Reporting and Interpreting Bonds
Chapter 10
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.
Characteristics of Bonds Payable
Interest 10%
6/30 & 12/31
Face Value $1,000
BOND PAYABLE
Bond Date 1/1/09
1.
2.
3.
4.
5.
Maturity Date 1/1/19
Face Value (Maturity or Par Value, Principal)
Maturity Date
Other Factors:
Stated Interest Rate
6. Market Interest Rate
Interest Payment Dates
7. Issue Date
Bond Date
McGraw-Hill/Irwin
Slide 2
Characteristics of Bonds Payable
$
Company
Issuing
Bonds
$
Periodic
Payments
$Interest
Bond Issue
Price $
$
Bond
Principal
Certificate
Payment at End of
Bond Term
Investor
Buying
Bonds
$
Bonds payables are long-term debt
for the issuing company.
McGraw-Hill/Irwin
Slide 3
Reporting Bond Transactions
Present Value of the Principal (a single payment)
+ Present Value of the Interest Payments (an annuity)
= Issue Price of the Bond
Interest
Rates
Bond
Price
Stated
Rate
=
Stated
Rate
< Market Bond <
Stated
Rate
> Market Bond >
McGraw-Hill/Irwin
Market Bond
Par Value
=
Rate Price
of the Bond
Rate
Rate
Price
Price
Accounting for
the Difference
There is no difference
to account for.
Par Value
of the Bond
The difference is accounted
for as a bond discount.
Par Value
of the Bond
The difference is accounted
for as a bond premium.
Slide 4
Bonds Issued at Par
On January 1, 2013, Harrah’s issues $100,000
in bonds having a stated rate of 10%
annually. The bonds mature in 10 years
and interest is paid semiannually. The
market rate is 10% annually.
This bond is issued at par.
GENERAL JOURNAL
Interest
Bond
Accounting
for
Date
Description
Debit
Credit
Jan Rates
1 Cash (+A)
Price
the100,000
Difference
Stated = Market
Bond
Value
Bonds
Payable
(+L)
= Par
Rate
Rate Price
of the Bond
McGraw-Hill/Irwin
There is no difference
100,000
to account for.
Slide 5
Bonds Issued at Par
Here is the entry made every six months to record
the interest payment.
GENERAL JOURNAL
Date
Description
Bond Interest Expense (+E, -SE)
Cash (-A)
Debit
Credit
5,000
5,000
Here is the entry to record the maturity
of the bonds.
GENERAL JOURNAL
Date
Description
Bonds Payable (-L)
Cash (-A)
McGraw-Hill/Irwin
Debit
Credit
100,000
100,000
Slide 6
Bonds Issued at Discount
On January 1, 2013, Harrah’s issues $100,000
in bonds having a stated rate of 10%
annually. The bonds mature in 10 years
(Dec. 31, 2023) and interest is paid
semiannually. The market rate is 12%
annually.
This bond is issued at a discount.
Interest
Rates
Bond
Price
Accounting for
the Difference
Stated < Market Bond < Par Value The difference is accounted
Rate
Rate Price
of the Bond
for as a bond discount.
McGraw-Hill/Irwin
Slide 7
Bonds Issued at Discount
The issue price of a bond is
composed of the present value
of two items:
•Principal (a single amount)
•Interest (an annuity)
First, let’s
compute the
present value of
the principal.
Market
rate of 12%
÷ 2 interest
periods
per year
= 6%to
Use
the present
value
of a single
amount
table
find
the appropriate
factor.
Bond term of
10 years
× 2 periods per
year = 20 periods
Present Value
Single Amount =
$
31,180 =
McGraw-Hill/Irwin
Principal
$ 100,000
× Factor (i=6.0% , n=20)
× 0.3118
Slide 8
Bonds Issued at Discount
The issue price of a bond is
composed of the present value
of two items:
•Principal (a single amount)
•Interest (an annuity)
Now, let’s
compute the
present value of
the interest.
Market
of 12%
÷ 2 interest
periods per
yearto= find
6%
Use
the rate
present
value
of an annuity
table
the
appropriate
Bond term of 10
years
× 2 periodsfactor.
per year = 20 periods
Present Value
Annuity
=
$
57,350 =
McGraw-Hill/Irwin
Payment
$
5,000
× Factor (i=6.0% , n=20)
× 11.4699
Slide 9
Bonds Issued at Discount
The issue price of a bond is
composed of the present value
of two items:
•Principal (a single amount)
•Interest (an annuity)
$
+
= $
Finally, we can
determine the
issue price of
the bond.
31,180 Present Value of the Principal
57,350 Present Value of the Interest
88,530 Present Value of the Bonds
The $88,530 is less than the face amount of
$100,000, so the bonds are issued at a discount
of $11,470.
McGraw-Hill/Irwin
Slide 10
Bonds Issued at Discount
Here is the journal entry to record the
bond issued at a discount.
GENERAL JOURNAL
Date
Jan
Description
1 Cash (+A)
Discount on Bonds Payable (+XL, -L)
Bonds Payable (+L)
Debit
Credit
88,530
11,470
100,000
This is a contra-liability account and appears in
the liability section of the balance sheet.
McGraw-Hill/Irwin
Slide 11
Bonds Issued at Discount
At January 1, 2013
Long-Term Liabilities
Bonds Payable, 10%
Due Dec. 31, 2018
Less: Bond Discount
Total L-T Liabilities
McGraw-Hill/Irwin
$
100,000
$
(11,470)
88,530
The discount
will be
amortized
over the 10year life of the
bonds.
Two methods
of amortization
are commonly
used:
Straight-line
(not GAAP)
Effectiveinterest.
Slide 12
Date
1/1/2013
6/30/2013
12/31/2013
6/30/2014
12/31/2014
6/30/2015
12/31/2015
6/30/2022
12/31/2022
Straight-Line Amortization Table
Interest
Interest
Discount Unamortized
Book
Payment Expense* Amortization* Discount
Value
$
11,470 $ 88,530
$ 5,000 $ 5,574 $
574
10,897
89,104
5,000
5,574
574
10,323
89,677
5,000
5,574
574
9,750
90,251
5,000
5,574
574
9,176
90,824
5,000
5,574
574
8,603
91,398
5,000
5,574
574
8,029
91,971
.................................
.................................
5,000
5,574
574
574
99,426
5,000
5,574
574
0
100,000
$ 100,000 $ 111,470 $
11,470
* Rounded.
McGraw-Hill/Irwin
Slide 13
Reporting Interest Expense:
Effective-interest Amortization
 The effective interest method
is the theoretically preferred
method.
 Compute interest expense by
multiplying the current unpaid
balance times the market rate
of interest.
 The discount amortization is
the difference between
interest expense and the cash
paid (or accrued) for interest.
McGraw-Hill/Irwin
Slide 14
Reporting Interest Expense:
Effective-interest Amortization
Harrah’s issued their bonds on Jan. 1, 2013. The
issue price was $88,530. The bonds have a 10year maturity and $5,000 interest is paid
semiannually. (market rate =12%)
n/
Unpaid
Balance
×
Effective
Interest
Rate
×
12
Compute the periodic discount amortization
using
the effective
method.
1/ = $5,312
$88,530
× 12% × interest
2
Discount
Amortization
$
312
McGraw-Hill/Irwin
=
=
Total
Interest
$
5,312
-
Cash Paid
for Interest
$
5,000
Slide 15
Reporting Interest Expense:
Effective-interest Amortization
GENERAL JOURNAL
Date
Description
Debit
Jun 30 Interest Expense (+E, -SE)
5,312
Discount on Bonds Payable (-XL, +L)
Cash (-A)
Harrah's
Partial Balance Sheet
At June 30, 2013
Long-Term Liabilities
Bonds Payable, 10%
Due Dec. 31, 2018
Less: Bond Discount
Total L-T Liabilities
McGraw-Hill/Irwin
$
100,000
$
(11,158)
88,842
Credit
312
5,000
As the
discount is
amortized, the
carrying
amount of the
bonds
increases.
Slide 16
Date
1/1/2013
6/30/2013
12/31/2013
6/30/2014
12/31/2014
6/30/2015
12/31/2015
6/30/2022
12/31/2022
Effective-Interest Amortization Table
Interest
Interest
Discount Unamortized
Book
Payment Expense* Amortization* Discount*
Value
$
11,470 $ 88,530
$ 5,000 $ 5,312 $
312
11,158
88,842
5,000
5,331
331
10,828
89,172
5,000
5,350
350
10,477
89,523
5,000
5,371
371
10,106
89,894
5,000
5,394
394
9,712
90,288
5,000
5,417
417
9,295
90,705
.................................
.................................
5,000
5,890
890
944
99,056
5,000
5,943
943
0
100,000
$ 100,000 $ 111,470 $
11,470
* Rounded.
McGraw-Hill/Irwin
Slide 17
Bonds Issued at Premium
On January 1, 2013, Harrah’s issues $100,000
in bonds having a stated rate of 10%
annually. The bonds mature in 10 years
(Dec. 31, 2023) and interest is paid
semiannually. The market rate is 8%
annually.
This bond is issued at a premium.
Interest
Rates
Bond
Price
Accounting for
the Difference
Stated > Market Bond > Par Value The difference is accounted
Rate
Rate Price
of the Bond
for as a bond premium.
McGraw-Hill/Irwin
Slide 18
Bonds Issued at Premium
The issue price of a bond is
composed of the present value
of two items:
•Principal (a single amount)
•Interest (an annuity)
First, let’s
compute the
present value of
the principal.
Market
rate of 8%
÷ 2 interest
periods
per yeartable
= 4% to
Use
the present
value
of a single
amount
find
the appropriate
factor.
Bond term of
10 years
× 2 periods per
year = 20 periods
Present Value
Single Amount =
$
45,640 =
McGraw-Hill/Irwin
Principal
$ 100,000
× Factor (i=4.0% , n=20)
× 0.4564
Slide 19
Bonds Issued at Premium
The issue price of a bond is
composed of the present value
of two items:
•Principal (a single amount)
•Interest (an annuity)
Now, let’s
compute the
present value of
the interest.
Market
rate of 8%value
÷ 2 interest
yearto
= 4%
Use
the present
of an periods
annuityper
table
find
the
appropriate
Bond term of 10
years
× 2 periodsfactor.
per year = 20 periods
Present Value
Annuity
=
$
67,952 =
McGraw-Hill/Irwin
Payment
$
5,000
× Factor (i=4.0% , n=20)
× 13.5903
Slide 20
Bonds Issued at Premium
The issue price of a bond is
composed of the present value
of two items:
•Principal (a single amount)
•Interest (an annuity)
$
+
= $
Finally, we can
determine the
issue price of
the bond.
45,640 Present Value of the Principal
67,952 Present Value of the Interest
113,592 Present Value of the Bonds
The $113,592 is greater than the face amount of
$100,000, so the bonds are issued at a
premium of $13,592.
McGraw-Hill/Irwin
Slide 21
Bonds Issued at Premium
GENERAL JOURNAL
Date
Jan
Description
Debit
1 Cash (+A)
Premium on Bonds Payable (+L)
Bonds Payable (+L)
Credit
113,592
13,592
100,000
Harrah's
This is an adjunct-liability
account and appears
The
premium
Partial Balance Sheet
in the liability
section
of the balance sheet.
At January
1, 2013
Long-Term Liabilities
Bonds Payable, 10%
Due Dec. 31, 2018
Add: Bond Premium
Total L-T Liabilities
McGraw-Hill/Irwin
$
100,000
$
13,592
113,592
will be
amortized
over the 10year life of the
bonds.
Slide 22
Date
1/1/2013
6/30/2013
12/31/2013
6/30/2014
12/31/2014
6/30/2015
12/31/2015
6/30/2022
12/31/2022
Effective-Interest Amortization Table
Interest
Interest
Premium Unamortized
Book
Payment Expense* Amortization* Premium*
Value
$
13,592 $ 113,592
$ 5,000 $ 4,544 $
456
13,136
113,136
5,000
4,525
475
12,661
112,661
5,000
4,506
494
12,168
112,168
5,000
4,487
513
11,654
111,654
5,000
4,466
534
11,120
111,120
5,000
4,445
555
10,565
110,565
.................................
.................................
5,000
4,076
924
965
100,965
*
5,000
4,039
965
0
100,000
$ 100,000 $ 86,408 $
13,592
* Rounded.
McGraw-Hill/Irwin
Slide 23
Reporting Interest Expense:
Effective-interest Amortization
Here is the journal entry to record the payment
of interest and the premium amortization for
the six months ending on June 30, 2013
.
GENERAL JOURNAL
Date
Description
Jun 30 Interest Expense (+E, -SE)
Premium on Bonds Payable (-L)
Cash (-A)
McGraw-Hill/Irwin
Debit
Credit
4,544
456
5,000
Slide 24
Early Retirement of Debt
 Occasionally, the issuing
company will call (repay
early) some or all of its
bonds.
 Gains/losses are
calculated by comparing
the bond call amount
with the book value of the
bond.
Book Value > Retirement Price = Gain
Book Value < Retirement Price = Loss
McGraw-Hill/Irwin
Slide 25
Focus on Cash Flows
Financing Activities –
 Issuance of bonds (a cash inflow)
 Retire debt (a cash outflow)
 Repay bond principal at maturity (a
cash outflow)
Remember that
payment of interest
is an operating
activity.
McGraw-Hill/Irwin
Slide 26
Debt-to-Equity Ratio
Debt-to-Equity
=
Total Liabilities
Stockholders’ Equity
This ratio shows the relationship between
the amount of capital provided by owners
and the amount provided by creditors. In
general, a high ratio suggest that a
company relies heavily on funds provided
by creditors.
McGraw-Hill/Irwin
Slide 27
Times Interest Earned Ratio
Times Interest
=
Earned
Net income + Interest expense
+ Income tax expense
Interest expense
The ratio shows the amount of resources
generated for each dollar of interest
expense. In general, a high ratio is
viewed more favorable than a low ratio.
McGraw-Hill/Irwin
Slide 28
End of Chapter 10
© 2008 The McGraw-Hill Companies, Inc.