Professional Documents
Culture Documents
Chapter Outline
Bonds payable: An introduction
A.
2.
B.
C.
Purchasers receive a bond certificate bearing the name of the issuer that includes
the following information:
a.
b.
c.
The stated interest rate and the interest dates (generally semi-annually).
2.
3.
4.
A bond is issued at a premium when issued at a price above its maturity value. A bond is
issued at a discount when issued at a price below its maturity value.
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D.
E.
1.
As a bond approaches the maturity date, the price of a bond moves toward its
maturity value.
2.
The market value is equal to the maturity value (par value) on the maturity date.
3.
Refer to Exhibit 15-2 to see how bond information is quoted in the Wall Street
Journal.
The purchase price of a bond, the amount an investor is willing to pay for it, is affected
by the time value of moneythe fact that money earns income over time.
1.
The amount a person would pay at the present time to receive a greater amount at
a future date is the present value. (Refer to the Appendix for a detailed
discussion.)
2.
Two interest rates work to set the market price of a bondthe stated interest rate and
the market interest rate. The market price is the maximum amount that an investor will
pay for a bond.
1.
The stated interest rate (or contract rate) determines the cash interest paid. The
stated rate is set by the bond stated and does not change during the life of the
bonds.
2.
The market interest rate (or effective rate) is the rate investors demand for
loaning their money and may vary from day to day. (Exhibit 15-3 summarizes
how these two interest rates interact to determine bond prices.)
a.
If investors demand a higher rate than the stated rate, the bonds will sell at
a discount.
b.
If investors demand a lower rate than the stated rate, the bonds will sell at
a premium.
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Journal entries for bonds issued at maturity (par) value on an interest date follow:
1.
On the date of issuance:
Cash
XX
Bonds Payable
XX
2.
3.
B.
XX
XX
XX
Bonds are issued at a discount because the market interest rate is greater than the stated
interest rate. The account, Discount on Bonds Payable, a contra account, records the
difference between the issue price and the maturity value. This account balance must be
amortized (reduced) over the life of the bonds.
1.
2.
$XX
XX
$XX
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2.
B.
3.
4.
Bonds are issued at a premium when the market interest rate is less than the stated
interest rate. The account, Premium on Bonds Payable is added to Bonds Payable to
show the carrying amount of the bonds. This account must also be amortized over the
life of the bonds.
1.
XX
Bonds Payable
XX
Premium on Bonds Payable XX
2.
b.
The entry to record the interest payment and amortization of the premium
is:
Interest Expense
XX
Premium on Bonds Payable XX
Cash
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XX
C.
Bonds payable are reported on the balance sheet at maturity value plus any bond
premium or minus bond discount. Over the life of the bonds, the balance of any
premium/discount will be reduced to zero.
Bonds Payable (par value)
Plus: Premium on Bonds Payable (unamortized portion)
D.
$XX
XX
$XX
If the year-end is not an interest-payment date, an entry is required to accrue interest and
to amortize a portion of the premium or discount based on the number of months since
the last interest date. This entry results in both the correct amount of interest expense and
the correct carrying amount.
1.
2.
B.
Bonds issued between interest dates are sold at their market value plus accrued
interest, that is, the interest since the last semiannual interest date.
1.
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Cash
XX
Bonds Payable
Interest Payable
2.
D.
XX
On the next interest date, the issuer will pay six months interest; however, the
interest expense recorded is for the amount of time the bonds have been
outstanding.
Interest Payable
Interest Expense
Cash
C.
XX
XX
XX
XX
Normally, companies wait until maturity to pay off bonds payable. If a company wants to
retire the bonds early, two options exist.
1.
If the bonds are callable, the issuer may call the bonds, that is, retire the bonds at
some specified price (usually above par).
2.
Alternatively, the company may purchase the bonds at the current market
price. In either case, the journal entry is the same.
2.
Write off the portion of Discount or Premium that relates to the portion of bonds
being retired.
3.
E.
Convertible bonds payable allow the bondholder the option to exchange the bonds for
common stock.
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1.
Bondholders may convert if the market price of the common stock gets high
enough.
2.
The carrying amount of the bonds becomes the amount of the new stockholders'
equity.
3.
The journal entry removes bonds payable and the related unamortized premium or
discount from the accounts and increases common stock and paid-in capital in
excess of par; no gain or loss is recorded.
F.
Serial bonds are payable in installments. The portion of the bonds payable within one
yearthe current portion of long-term debtis reported as a current liability; the
remainder is considered long-term.
(See
B.
The advantage of issuing common stock is that it is less risky than borrowing money.
C.
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Appendix to Chapter 15
A.
The term time value of money refers to the fact that money earns interest over time.
Interest is the cost of using money. The process of computing a future value is called
accumulating because the future value is more than the present value.
B.
The present value (PV) is the amount that would have to be invested now to accumulate
to some specified future amount. The process of computing present value is called
discounting.
1.
2.
3.
The present value of a single sum can also be computed using the Present Value
of $1 table (Exhibit 15A- 1). Find the factor in the table that corresponds with the
number of interest periods and the interest rate. Multiply that factor by the future
value.
4.
The present value of an annuity is determined by using the factors in the Present
Value of an Annuity table (Exhibit 15-A 2). To compute the present value of an
annuity, find the factor in the table that corresponds with the number of periods
and the interest rate. Multiply that factor by the amount of the periodic payment
(receipt).
5.
The present value techniques can be applied to determining the market price of a
bond. The market price of a bond is determined by making two computations:
a.
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C.
D.
b.
c.
Add the amounts from a. and b. to determine the market price of the
bonds.
Under the straight-line method, the interest expense is the same dollar amount
each period. Under the effective-interest method, the interest expense is a
constant percentage of the bonds carrying amount.
2.
3.
The total amount of premium or discount amortized is the same under the two
methods; the total expense is the same.
When using the effective-interest method, an amortization table is helpful. The table
has the following headings as shown in Exhibit 15-A3 (discount) and Exhibit 15-A4
(premium):
1.
2.
3.
4.
5.
6.
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E.
The accounts debited and credited are the same under the effective-interest method and
the straight-line method. Only the amounts are different. These entries are summarized
below with a column reference from the amortization table.
Bonds issued at a discount
At issuance
Cash (E)
XX
Cash (E)
XX
Discount on Bonds Payable (D)
XX
Bonds Payable
XX
Bonds Payable
XX
Premium on Bonds Payable (D)
XX
To pay interest
Interest Expense (B)
XX
Interest Expense (B)
XX
Discount on Bonds Payable (C) XX
Premium on Bonds Payable (C)
XX
Cash (A)
XX
Cash (A)
XX
To accrue interest
Interest Expense (B)
XX
Interest Expense (B)
XX
Interest Payable (A)
XX
Premium on Bonds Payable (C)
XX
Discount on Bonds Payable (C)
XX
Interest Payable (A)
XX
To pay interest following accrual
Interest Expense (B)
XX
Interest Expense (B)
XX
Interest Payable (A)
XX
Premium on Bonds Payable (C)
XX
Discount on Bonds Payable (C)
XX
Interest Payable (A)
XX
Cash (A)
XX
Cash (A)
XX
Note: the amounts from the table must be adjusted for partial periods when interest is accrued
and in the following entry when the payment is made.
F.
When bonds are issued at a discount, the carrying amount increases each period until
maturity.(Exhibit 15-A3).
G.
When bonds are issued at a premium, the carrying amount increases each period until
maturity. (Exhibit 15-A4).
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