Acct 414
Professor boss5
Serial Bonds
Description:
Bonds that provide for installment liquidation of principal. Bonds with
differing maturity dates no doubt sell at different prices (different risk to
investor). GAAP does not address assignment of different rates of interest
for each term - it has been assumed that the issue yields a single interest rate.
In rare instances, bonds can be treated as simply several term issues. When
bonds are issued and each term is sold with identifiable interest rates, then
bonds can be accounted for as individual term issues.
When serial bonds are issued and the yield rate for each term issue cannot be
determined, then two methods are available:
Effective Interest Method: Determine the effective interest rate (IRR
for most spreadsheet programs) for the cash outflows and use this rate
to calculate interest expense. Difference between interest expense and
interest paid produces the amortization of premium or discount on the
bonds.
Bonds Outstanding Method: Determine premium or discount
proportionate to the face value of the bonds outstanding at the
beginning of a period to the total bonds outstanding for all periods.
(Sort of a sum of the “bonds digits” approach)
Early Retirement of Serial Bonds
Gain or loss calculated on the difference between call or retirement price and
carrying value at date of retirement.
Classification as an extraordinary gain or loss is no longer automatic. Since
the issuance of FASB No. 145, gains and losses from the early retirement of
debt will be included in income from operations unless the event meets the
usual rules (i.e., unusual in nature and infrequent in occurrence)
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Professor boss5
Serial Bond Example:
NQK Inc. issues $100,000 face value of semi-annual bonds with stated interest rate
of 12% on January 1, 20X1. Principal in the amount of $20,000 will be repaid each
year beginning 12/31/X1 until the bonds are fully retired. Interest is paid on June
30 and December 31 of each year. The amount received from Investment Banker is
$95,409.
Stated interest rate
Yield rate
Total face value
Face value per year
Bond period in years
Interest payments per year
Proceeds of bond issue
12%
?
100,000
20,000
5
2
95,409
For the effective interest method, the first step is to determine the effective interest rate.
How can we do this? Is it an ordinary annuity problem?
Cash flows:
Period
Interest Paid
Principal Re-paid
Cash Flow
0
1
2
3
4
5
6
7
8
9
10
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Effective Interest Amortization - Serial Bond
Period
Interest Paid
Principal Repaid
Interest Expense
Amount
Amortized
Carrying Value
of Bonds
0
1
2
3
4
5
6
7
8
9
10
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Premium or
Discount Balance
Face Value of
Bonds
Outstanding
Acct 414
Professor boss5
Bonds Outstanding Amortization - Serial Bonds
Period
Interest Paid
Principal
Re-paid
Interest
Expense
Amount
Amortized
Carrying
Value of
Bonds
Premium or
Discount
Balance
0
1
2
3
4
5
6
7
8
9
10
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Face Value of
Bonds
Outstanding
Amortization
Fraction
Acct 414
Professor boss5
Solution for Example Problem
EFFECTIVE INTEREST AMORTIZATION SCHEDULE
6.00%
Period
Date
Interest
Principal
Paid
Payment
0
01/01/01
0
1
06/30/01
6,000
2
12/31/01
6,000
20,000
3
06/30/02
4,800
4
12/31/02
4,800
20,000
5
06/30/03
3,600
6
12/31/03
3,600
20,000
7
06/30/04
2,400
8
12/31/04
2,400
20,000
9
06/30/05
1,200
10
12/31/05
1,200
20,000
11
06/30/06
0
Journal entries:
7.000%
Interest
Expense
0
6,679
6,726
5,377
5,417
4,061
4,093
2,727
2,750
1,375
1,387
0
Face Value:
100,000
Carrying
BALANCE
Value
DISCOUNT
0
95,409
(4,591)
(679)
96,088
(3,912)
(726)
76,814
(3,186)
(577)
77,391
(2,609)
(617)
58,008
(1,992)
(461)
58,468
(1,532)
(493)
38,961
(1,039)
(327)
39,288
(712)
(350)
19,638
(362)
(175)
19,813
(187)
(187)
0
0
(0)
0
0
Amortization
FACE
VALUE
100,000
100,000
80,000
80,000
60,000
60,000
40,000
40,000
20,000
20,000
0
0
Effective Interest Method
01/01/01 Cash
Discount on Bonds Payable
Bonds Payable
Debit
95,409
4,591
100,000
06/30/01 Interest Expense
Discount on Bonds Payable
Cash
6,679
12/31/01 Interest expense
Bonds Payable
Discount on Bonds Payable
Cash
6,726
20,000
679
6,000
726
26,000
133,405
533571276 as of 2/17/16
Credit
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133,405
Acct 414
Professor boss5
Serial Bond Example
Bonds Outstanding Method
Comments: The amortization fraction is determined based on total principal outstanding at each interest payment date. It
is similar to sum of the years digits depreciation.. Note that the first fraction is 100/600 and the last fraction is 20/600.
With this method, we do not need to know the effective interest rate. Before calculators and spreadsheets, the bonds
outstanding method was the only efficient way to handle a serial bond!
Period
0
1
2
3
4
5
6
7
8
9
10
Date
01/01/01
06/30/01
12/31/01
06/30/02
12/31/02
06/30/03
12/31/03
06/30/04
12/31/04
06/30/05
12/31/05
Journal entries:
6.00%
Interest
Paid
6,000
6,000
4,800
4,800
3,600
3,600
2,400
2,400
1,200
1,200
Principal
Payment
20,000
20,000
20,000
20,000
20,000
Interest
Expense
6,765
6,765
5,412
5,412
4,059
4,059
2,706
2,706
1,353
1,353
Amortization
(765)
(765)
(612)
(612)
(459)
(459)
(306)
(306)
(153)
(153)
Face Value:
Carrying
Value
95,409
96,174
76,939
77,551
58,164
58,623
39,082
39,388
19,694
19,847
0
FACE
VALUE
100,000
100,000
80,000
80,000
60,000
60,000
40,000
40,000
20,000
20,000
0
600,000
Bonds Outstanding Method
01/01/01 Cash
Discount on Bonds Payable
Bonds Payable
Debit
95,409
4,591
Credit
100,000
06/30/01 Interest Expense
Discount on Bonds Payable
Cash
6,765
12/31/01 Interest expense
Bonds Payable
Discount on Bonds Payable
Cash
6,765
20,000
765
6,000
133,530
533571276 as of 2/17/16
100,000
BALANCE
DISCOUNT
(4,591)
(3,826)
(3,061)
(2,449)
(1,836)
(1,377)
(918)
(612)
(306)
(153)
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765
26,000
133,530
Amortization
Fraction
10/600 = 0.16667
10/600 = 0.16667
80/600 = 0.13333
80/600 = 0.13333
60/600 = 0.10000
60/600 = 0.10000
40/600 = 0.06667
40/600 = 0.06667
20/600 = 0.03333
20/600 = 0.03333