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1、Chapter 09Bonds and Long-Term Notes,The Nature of Long-Term Debt,Liabilities signify creditors interest in a companys assets.,A note payable and not receivable are two sides of the same coin.,Periodic interest in the effective interest rate times the amount of the debt outstanding during the period.
2、Debt is reported at its present value,A bond payable divides a large liability into many smaller liabilities.,Corporations issuing bonds are obligated to repay a stated amount at a specified maturity date and period interest between the issue date.,Bonds,At Bond Issuance Date,Company Issuing Bonds,I
3、nvestor Buying Bonds,The Bond Indenture,The specific promises made to bondholders are described in a document called a bond indenture.,Mortgage Bond secured by lien on specific real estate owned by the issuer.,Callable Bond allows company to buy back outstanding bonds prior to maturity.,Coupon Bond
4、pays interest when investor submits attached coupon.,Debenture Bondsecured by the“full faith and credit”of company.,Recording Bonds at Issuance,On January 1,2011,Masterwear Industries issued$700,000 of 12%bonds.Interest of$42,000 is payable semiannually on June 30 and December 31.The bonds mature in
5、 three years an unrealistically short maturity to shorten the illustration.The entire bond issue was sold in a private placement to United Intergroup,Inc.at face amount.,At Issuance(January 1),Masterwear(Issuer)Cash700,000Bonds payable 700,000,United(Investor)Investment in bonds(face amount)700,000C
6、ash 700,000,Determining the Selling Price,Determining the Selling Price,On January 1,2011,Masterwear Industries issued$700,000 of 12%bonds,dated January 1.Interest is payable semiannually on June 30 and December 31.The bonds mature in three years.The market yield for bonds of similar risk and maturi
7、ty is 14%.The entire bond issue was purchased by United Intergroup.,Because interest is paid semiannually,the present value calculations use:(a)the semiannual stated rate(6%),(b)the semiannual market rate(7%),and(c)6(3 x 2)semi-annual periods.,Present value of an ordinary annuity of$1:n=6,i=7%,prese
8、nt value of$1:n=6,i=7%,Bonds Issued at a Discount,Masterwear(Issuer)Cash666,633Discount on bonds payable 33,367Bonds payable 700,000,United(Investor)Investment in bonds 700,000Discount on bond investment 33,367Cash 666,633,Alternative“net method”,Masterwear(Issuer)Cash666,633Bonds payable 666,633,Un
9、ited(Investor)Investment in bonds 666,633Cash 666,633,Determining Interest Effective Interest Method,Interest accrues on an outstanding debt at a constant percentage of the debt each period.Interest each period is recorded as the effective market rate of interest multiplied by the outstanding balanc
10、e of the debt(during the interest period).,The bond indenture calls for semiannual interest payments of only$42,000 the stated rate(6%)times the face value of$700,000.The difference($4,664)increases the liability and is reflected as a reduction in the discount(a valuation account).,Interest is recor
11、ded as expense to the issuer and revenue to the investor.For the first six-month interest period the amount is calculated as follows:$666,633(14%2)=$46,664Outstanding Balance Effective Rate Effective Interest,Recording Interest Expense,The effective interest is calculated each period as the market r
12、ate times the amount of the debt outstanding during the interest period.,At the First Interest Date(June 30),Masterwear(Issuer)Interest expense46,664Discount on bonds payable 4,664Cash 42,000,United(Investor)Cash42,000Discount on bond investment 4,664Investment revenue 46,664,$700,000(12%2)=$42,000,
13、$666,633(14%2)=$46,664,$46,664-$42,000=$4,664,Bond Amortization Schedule,Here is a bond amortization schedule showing the cash interest,effective interest,discount amortization,and the carrying value of the bonds.,$666,633+$4,664=$671,297,Zero-Coupon Bonds,These bonds do not pay interest.Instead,the
14、y offer a return in the form of a“deep discount”from the face amount.,Bond Issued at Premium,On January 1,2011,Masterwear Industries issued$700,000 of 12%bonds,dated January 1.Interest is payable semiannually on June 30 and December 31.The bonds mature in three years.The market yield for bonds of si
15、milar risk and maturity is 10%.The entire bond issue was purchased by United Intergroup.,Because interest is paid semiannually,the present value calculations use:(a)the semiannual stated rate(6%),(b)the semiannual market rate(5%),and(c)6(3 x 2)semi-annual periods.,Present value of an ordinary annuit
16、y of$1:n=6,i=6%,present value of$1:n=6,i=5%,Premium Amortization Schedule,Here is a bond amortization schedule showing the cash interest,effective interest,premium amortization,and the carrying value of the bonds.,$735,533-$5,223=$730,310,$735,533 5%=$36,777,Bonds Sold at a Premium,Masterwear(Issuer
17、)Cash735,533Premium on bonds payable 35,533Bonds payable 700,000,United(Investor)Investment in bonds 700,000Premium on bond investment 35,533Cash 735,533,Interest expense and interest revenue will be recognized in a manner consistent with bonds issued at a discount.,Premium and Discount Amortization
18、 Compared,1/1/11,12/31/13,$700,000,$735,533,$666,633,Premium Amortization,Discount Amortization,When Financial Statements Are Prepared Between Interest Dates,Masterwear and United both have October 31st year-ends.,On January 1,2011,Masterwear Industries issued$700,000 of 12%bonds,dated January 1.Int
19、erest is payable semiannually on June 30 and December 31.The bonds mature in three years.The market yield for bonds of similar risk and maturity is 14%.The entire bond issue was purchased by United Intergroup at a cost of$666,633.,$700,000(12%2)=$42,000,$666,633(14%2)=$46,664,Semi-annual Stated Inte
20、rest,June 30,2011 Effective Interest,When Financial Statements Are Prepared Between Interest Dates,Year-end is on October 31,2011,before the second interest date of December 31,so we must accrue interest for 4 months from June 30 to October 31.,Year-end accrual of interest expense and interest incom
21、e.,Masterwear(Issuer)Interest expense31,327Discount on bonds payable 3,327Interest payable 28,000,United(Investor)Interest receivable28,000Discount on bond investment 3,327Investment revenue 31,327,$42,000 4/6=$28,000,$671,297 7%4/6=$31,327,$31,327-$28,000=$3,327,When Financial Statements Are Prepar
22、ed Between Interest Dates,On December 31,the next interest payment date,the following entries would be recorded.,Masterwear(Issuer)Interest expense23,496Interest payable21,000Discount on bonds payable 2,496Cash 42,000,United(Investor)Cash42,000Discount on bond investment 2,496Interest receivable21,0
23、00Investment revenue 23,496,The Straight-Line Method A Practical Expediency,Using the straight-line method of amortizing discounts and premiums,the discount in the earlier illustration would be allocated equally to the 6 semiannual periods(3 years):$33,367 6 periods=$5,561 per period,At Each of the
24、Six Interest Dates,Masterwear(Issuer)Interest expense47,561Discount on bonds payable 5,561Cash 42,000,United(Investor)Cash42,000Discount on bond investment 5,561Investment revenue 47,561,Debt Issue Costs,Legal Accounting Underwriting Commission Engraving Printing Registration Promotion,U.S.GAAP vs.I
25、FRS,Debt issue costs are recorded separately as an asset.Amortized over the term to maturity.,“Transaction costs”reduce the recorded amount of the debt.The cost of these services reduces the net cash the issuing company receives and the amount recorded for the debt.,Unless the recorded amount of the
26、 debt is reduced by the transaction costs,the higher effective interest rate is not reflected in a higher recorded interest expense.,Debt issue costs(called transaction costs under IFRS)are accounted for differently by U.S.GAAP and IFRS.,Long-Term Notes,Bank,PromissoryNote(Note Payable),Company(Borr
27、ower),Property,goods,or services.,The liability,note payable,is reported at its present value,similar to the accounting for bonds payable.,Long-Term Notes,On January 1,2011,Skill Graphics,Inc.,a product labelingand graphics firm,borrowed$700,000 cash from First BancCorpand issued a 3-year,$700,000 p
28、romissory note.Interest of$42,000 was payable semiannually on June 30 and December 31.,January 1,At Issuance,Skill Graphics(Borrower)Cash700,000Note payable 700,000,First BancCorp(Lender)Investment in bonds 700,000Cash 700,000,Long-Term Notes,At Each of the Six Interest Dates,At Maturity,Skill Graph
29、ics(Borrower)Interest expense 42,000Cash 42,000,First BancCorp(Lender)Cash 42,000Interest revenue 42,000,Skill Graphics(Borrower)Notes payable700,000Cash 700,000,First BancCorp(Lender)Cash700,000Notes receivable 700,000,Note Exchanged for Assets or Services,present value of$1:n=6,i=7%,Present value
30、of an ordinary annuity of$1:n=6,i=7%,Skill Graphics purchased a package labeling machine from HughesBarker Corporation by issuing a 12%,$700,000,3-year note that requires interest to be paid semiannually.The machine could have been purchased at a cash price of$666,633.The cash price implies an annua
31、l market rate of interest of 14%.That is,7%is the semiannual discount rate that yields a present value of$666,633 for the notes cash flows(interest plus principal)computed as follows:,The accounting treatment is the same whether the amount is determined directly from the market value of the machine
32、or indirectly as the present value of the note.,Note Exchanged for Assets or Services,At the Purchase Date(January 1),At the First Interest Date(June 30),Skill Graphics(Buyer/Issuer)Machinery 666,633Discount on note payable 33,367Notes payable 700,000,Hughes-Baker(Seller/Lender)Notes receivable700,0
33、00Discount on notes payable 33,367Sales revenue 666,633,Skill Graphics(Buyer/Issuer)Interest expense 46,664Discount on note payable 4,664Cash 42,000,Hughes-Baker(Seller/Lender)Cash42,000Discount on notes payable 4,664Investment revenue 46,664,Installment Notes,To compute cash payment use present val
34、ue tables.Each payment includes both an interest amount and a principal amount.Interest expense or revenue:Effective interest rate Outstanding balance of debt Interest expense or revenuePrincipal reduction:Cash amount Interest component Principal reduction per period,Installment Notes,$666,633 4.766
35、54=$139,857 amount of loan(from Table 4)installment n=6,i=7.0%payment,Notes often are paid in installments,rather than a single amount at maturity.,Rounded,Installment Notes,At the Purchase Date(January 1),At the First Interest Date(June 30),Skill Graphics(Buyer/Issuer)Machinery 666,633Notes payable
36、 666,633,Hughes-Baker(Seller/Lender)Notes receivable666,633Sales revenue 666,633,Skill Graphics(Buyer/Issuer)Interest expense 46,664Note payable 93,193Cash 139,857,Hughes-Baker(Seller/Lender)Cash 139,857Notes receivable 93,193Interest revenue 46,664,Financial Statement Disclosures,Disclosures includ
37、e fair value,the nature of the companys liabilities,interest rates,maturity dates,call provisions,conversion options,restrictions imposed by creditors,any assets pledges as collateral and the aggregate amounts payable for each of the next five years.,Decision Makers Perspective,Early Extinguishment
38、of Debt,Debt retired at maturity results in no gains or losses.,Debt retired before maturity may result in an gain or loss on extinguishment.Cash Proceeds Book Value=Gain or Loss,BUT,Early Extinguishment of Debt,Illustration On January 1,2011,Masterwear Industries called its$700,000,12%bonds when th
39、eir carrying amount was$676,290.The indenture specified a call price of$685,000.The bonds were issued previously at a price to yield 14%.,$685,000 676,290,$700,000 676,290,Masterwear(Issuer)Bonds payable700,000Loss on early extinguishment 8,710Discount on bonds payable 23,710Cash 685,000,Convertible
40、 Bonds,Some bonds may be converted into common stock at the option of the holder.When bonds are converted the issuer(1)updates interest expense and(2)amortization of discount or premium to the date of conversion.The bonds are reduced and shares of common stock are increased.,Bonds into Stock,Convert
41、ible Bonds,On January 1,2011,HTL Manufacturers issued$100,000,000 of 8%convertible debentures due 2031 at 103(103%of face value).The bonds are convertible at the option of the holder into$1 par common stock at a conversion ratio of 40 shares per$1,000 bond.HTL recently issued nonconvertible,20 year,
42、8%debentures at 98.,At Issuance,January 1,2011,$10,000,000 103%,HTL(Issuer)Cash 103,000,000Convertible bonds payable 100,000,000Premium on bonds payable 3,000,000,Convertible Bonds,Assume the bondholder exercise one-half of their option to convert the bonds into shares of stock when there is an unam
43、ortized premium of$2,000,000 associated with these bonds.The bonds are removed from the accounting records and the new shares issued are recorded at the same amount(in other words,at the book value of the bonds).,HTL(Issuer)Convertible bonds payable50,000,000Premium on bonds payable 1,000,000Common
44、stock 2,000,000Paid-in capital excess of par 49,000,000,At Date of Exercise of One-half of the Bonds,50,000 bonds 40 shares$1 par=$2,000,000 par value,Induced Conversion,Companies sometimes try to induce conversion.The motivation might be to reduce debt and become a better risk to potential lenders
45、or achieve a lower debt-to-equity ratio.,When the specified call price is less than the conversion value of the bonds(the market value of the shares),calling the convertible bonds provides bondholders with incentive to convert.,U.S.GAAP vs.IFRSConvertible Bonds,Under IFRS,unlike U.S.GAAP,convertible
46、 debt is divided into its liability and equity elements.($in millions)Cash(103%$100million)103Convertible bonds payable(value of the debt only)98*Equityconversion option(difference)5*The discount is combined with the face amount of the bonds.This is the“net method”the preferred method under IFRS.Com
47、pound instruments such as this one are separated into their liability and equity components in accordance with IAS No.32.If the bonds have a separate fair value of$98 M,we record that amount as the liability and the remaining$5 M as equity.,Bonds With Detachable Warrants,Stock warrants provide the o
48、ption to purchase a specified number of shares of common stock at a specified option price per share within a stated period.A portion of the selling price of the bonds is allocated to the detachable stock warrants.,Bonds With Detachable Warrants,On January 1,2011,HTL issued$100,000,000 of 8%bonds du
49、e in 2018 at 130(103%of face value).Accompanying each$1,000 bond were 20 warrants.Each warrant permitted the holder to buy one share of$1 par common stock at$25 per share.Shortly after issuance,the warrants were listed on the stock exchange at$3 per warrant.,HTL(Issuer)Cash 103,000,000Discount on bo
50、nds payable 3,000,000Bonds payable 100,000,000Paid-in capital stock warrants 6,000,000,100,000 bonds 20 warrants$3,Bonds With Detachable Warrants,Assume one-half of the warrants(1,000,000)are exercised when the market value of HTLs common stock is$30 per share.The exercise price is$25 per common sha
