Chapter 14: Bonds
and Long-Term Notes
Part
P t 1 - Bonds
B d
Intermediate Accounting II
Dr. Chula King
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All Rights Reserved
Student Learning Outcomes
• Account for bonds at face value, at a discount, or
at a premium using the effective interest method





On issuance
Interest payment
Adjusting entry
At maturity
Before maturity
• Prepare and use an amortization table for bonds
issued at a discount or premium
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Back to Chapter 12
• Investment in bonds – Purchase of right to receive
 Periodic interest based on stated rate
 Amount due at maturity
• Market yyield or effective interest – used to
determine present value of interest and present
value of amount due at maturity
• Premium: Stated rate > Effective or Market rate
• Discount: Stated rate < Effective or Market rate
• Par: Stated rate = Effective or Market rate
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1
Back to Chapter 12 (continued)
• Investor purchases bond: Held-to-Maturity,
Available for Sale, Trading
• Accounting Issues
 Recording the Purchase
 Recording receipt of interest and discount/premium
amortization
 Recording adjusting entry related to interest accrual
and discount/premium amortization
 Recording disposition of investment
 Recognizing fair value (if available for sale or trading)
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Issuing Bonds
• Bond indenture – bond contract
• Promise to pay
 Sum of money at designated maturity date
 Periodic interest at specified rate on maturity
amount
• Paper certificate, typically $1,000 face value
• Interest usually paid semiannually
• Used when amount of capital needed is too
large for one lender to supply
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Valuation of Bonds Payable
• Selling price set by




Supply and demand of buyers and sellers
Relative risk
Market conditions
State of the economy
• Valued at present value of expected cash flows
 Periodic cash interest, plus
 Cash amount payable at maturity
 Discounted at market or effective interest rate
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Interest
• Stated, coupon or nominal rate: Interest rate
printed on the bond – used to determine cash
interest
 Bond issuer sets the rate
 Stated as a percentage of the bond face value (par)
• Market rate or effective yield: Rate that
provides acceptable return on investment given
issuer’s risk and market conditions – used to
determine present value
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For Example
• On January 1, 20X1, Apex, Inc., issued $100,000 face
value, 10% bonds that pay interest semiannually on
June 30 and December 31. The bonds mature in 3
years on December 31, 20X3.
1/1/X1
6/30/X1
|
|
5,000
12/31/X1 6/30/X2
|
5,000
|
5,000
12/31/X2 6/30/X3
|
5,000
|
5,000
#4, 6 payments @ ?
Issue
Price
12/31/X3
|
5,000
100,000
#2, 6 periods @ ?
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Market Rate (effective) = 10%: Par
1/1/X1
6/30/X1
|
|
5,000
12/31/X1 6/30/X2
|
5,000
|
5,000
12/31/X2 6/30/X3
|
5,000
|
5,000
12/31/X3
|
5,000
100,000
#4, 6 payments @ 5%
25,378
25 378 = 5.07569
5 07569 x 5,000
5 000
100,000
#2, 6 periods @ 5%
74,622 = .74622 x 100,000
Cash
Bonds Payable
100,000
100,000
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Market Rate (effective) = 8%:
Premium
1/1/X1
6/30/X1
|
|
5,000
12/31/X1 6/30/X2
|
5,000
|
5,000
12/31/X2 6/30/X3
|
5,000
|
5,000
12/31/X3
|
5,000
100,000
#4, 6 payments @ 4%
26,211
26 211 = 5.24214
5 24214 x 5,000
5 000
105,242
#2, 6 periods @ 4%
79,031 = .79031 x 100,000
Cash
105,242
Premium on B/P
Bonds Payable
5,242
100,000
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Market Rate (effective) = 12%:
Discount
1/1/X1
6/30/X1
|
|
5,000
12/31/X1 6/30/X2
|
5,000
|
5,000
12/31/X2 6/30/X3
|
5,000
|
5,000
12/31/X3
|
5,000
100,000
#4, 6 payments @ 6%
24,587
24 587 = 4.91732
4 91732 x 5,000
5 000
95,083
#2, 6 periods @ 6%
70,496 = .70496 x 100,000
Cash
Discount on B/P
Bonds Payable
95,083
4,917
100,000
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Effective Interest Method
• Produces periodic interest expense based on a
constant percentage (effective rate) applied to the
carrying value of the bonds
• Interest Expense = Effective Interest Rate x
Carrying Value of Bonds at beginning of period
• Interest Paid = Stated Interest Rate x Face
Amount of Bonds
• Amortization = Interest Expense – Interest Paid
• Change in Carrying Value = Beginning of period
value ± Amortization
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Interest: Issued at Par
6/30/X1
Interest Expense
5,000
Cash
5,000
(10% x 100,000 x 6/12)
12/31/X1 Interest Expense
5,000
Cash
5,000
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Interest: Issued at Premium
Date
1/1/X1
6/30/X1
12/31/X1
6/30/X2
12/31/X2
6/30/X3
12/31/X3
Cash Interest
Effective
Premium Carrying Value/
@ 5%
Interest @ 4% Amortization
Balance
105,242
5,000
4,210
790
104,452
5,000
4,178
822
103,630
5,000
5 000
4,145
4 145
855
102,775
102 775
5,000
4,111
889
101,886
5,000
4,075
925
100,961
5,000
4,038
962
100,000
6/30/X1
Interest Expense
Premium on B/P
Cash
12/31/X1 Interest Expense
Premium on B/P
Cash
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4,210
790
5,000
4,178
822
5,000
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Interest: Issued at Discount
Date
1/1/X1
6/30/X1
12/31/X1
6/30/X2
12/31/X2
6/30/X3
12/31/X3
6/30/X1
12/31/X1
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Cash Interest
Effective
Discount Carrying Value/
@ 5%
Interest @ 6% Amortization
Balance
95,083
5,000
5,705
705
95,788
5,000
5,747
747
96,535
5,000
5,792
792
97,327
5 000
5 792
97 327
5,000
5,840
840
98,167
5,000
5,890
890
99,057
5,000
5,943
943
100,000
Interest Expense
Discount on B/P
Cash
Interest Expense
Discount on B/P
Cash
5,705
705
5,000
5,747
747
5,000
5
Interest Payment Is Not at Year End
• On August 1, 20X1, Apex, Inc., issued
$100,000 face value, 10% bonds that pay
interest semiannually on January 31 and July
31.
31 The bonds mature in 3 years on July 31,
31
20X4.
• Effective Rate = 10%: Issue price = $100,000
• Effective Rate = 8%: Issue price = $105,242
• Effective Rate = 12%: Issue price = $95,083
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Interest: Issued at Par
12/31/X1 Interest Expense
4,167
Interest Payable
4,167
(10% x 100,000 x 5/12)
1/31/X2 Interest Expense *
833
Interest Payable
4,167
Cash
5,000
*(10% x 100,000 x 1/12)
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Interest: Issued at Premium
Date
8/1/X1
1/31/X2
7/31/X2
1/31/X3
7/31/X3
1/31/X4
7/31/X4
Cash Interest
Effective
Premium Carrying Value/
@ 5%
Interest @ 4% Amortization
Balance
105,242
5,000
4,210
790
104,452
5,000
4,178
822
103,630
5,000
4,145
855
102,775
5,000
4,111
889
101,886
5,000
4,075
925
100,961
5,000
4,038
962
100,000
12/31/X1 Interest Expense (4,210 x 5/6)
Premium on B/P (790 x 5/6)
Interest Payable (5,000 x 5/6)
1/31/X2 Interest Expense (4,210 x 1/6)
Interest Payable
Premium on B/P (790 x 1/6)
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Cash
All Rights Reserved
3,508
658
4,166
702
4,166
132
5,000
6
Interest: Issued at Discount
Date
8/1/X1
1/31/X2
7/31/X2
1/31/X3
7/31/X3
1/31/X4
7/31/X4
12/31/X1
1/31/X2
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Cash Interest
Effective
Discount Carrying Value/
@ 5%
Interest @ 6% Amortization
Balance
95,083
5,000
5,705
705
95,788
5,000
5,747
747
96,535
5,000
5,792
792
97,327
5,000
5,840
840
98,167
5 000
5 840
98 167
5,000
5,890
890
99,057
5,000
5,943
943
100,000
Interest Expense (5,705 x 5/6)
Discount on B/P (705 x 5/6)
Interest Payable (5,000 x 5/6)
Interest Expense (5,705 x 1/6)
Interest Payable
Discount on B/P (705 x 1/6)
Cash
4,754
588
4,166
951
4,166
117
5,000
Extinguishment of Debt at Maturity
• Effective Interest Method
 Premium amortization reduces interest expense
and reduces Carrying value, ultimately to par
 Discount amortization increases interest expense
and increases Carrying value, ultimately to par.
• Therefore, at maturity, no gain or loss results
Bonds Payable
100,000
Cash
100,000
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Early Extinguishment of Debt
• Gain or loss is the difference between the cash
paid to retire the bonds and the carrying value
of the debt.
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For Example
• On January 1, 2013, Apex, Inc., called its
$100,000, 10% bonds for $102,000 when their
carrying amount was $97,358. The bonds were
issued previously at a price to yield 12%, and pay
interest semiannually on June 30 & December 31.
Bonds Payable
100,000
Loss on early retirement of bonds
4,462
Discount on B/P (100,000 – 97,538)
2,462
Cash
102,000
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The Next Step
• Part 2 – Long-term Notes
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8