Professional Documents
Culture Documents
Leverage refers to a companys use of borrowed funds. By investing these funds, the
company expects to earn a return greater than the interest to be paid for their use and tehr
by benefit the stockholders.
Bonds Payable
Bond is a type of note in which a company agrees to pay the holder the face value at the
maturity date and usually to pay interest periodically at a specified rate on the face value.
Face Value(Par) is the amount of money that the issuer agrees to pay at maturity.
Maturity Date is the date on which the issuer of the bond agrees to pay the face value to
the to the holder.
Contract Rate is the rate at which the issuer of the bond agrees to pay interest each period
until maturity.
Bond Certificate is a legal document that specifies the face value, the annual interest
rate, the maturity date, and other characteristics of the bond issue.
Bond Indenture is a document (contract) that defines the rights of the bondholders.
3. If the yield is less than the contract rate, the purchasers of the bonds pay more
than the face value of the bonds the bonds are sold at a premium.
408,000
400,000
8,000
Book (Carrying) Value of a bond issue at any time is the face value plus any
unamortized premium or minus any unamortized discount.
Bonds are often sold after their authorization date and between interest payment
periods.
When a company sells bonds between interest dates, to reduce the record keeping
for the first interest payment, the company normally will collect from the
investors both the selling price and the interest accrued on the bonds from the
interest payment date prior to the date of sale.
Example: A company issues $800,000 on March 1, 2001 of 10-year 12% coupon bonds
dated January 1, 2001 at par. Interest is paid semiannually on January 1 and July 1. The
following entry would be recorded on March 1, 2001:
Cash
816,000
Interest Expense
Bonds Payable
16,000
800,000
48,000
48,000
It is possible to record the previous transaction by using a liability account that reflects
the fact that part of the proceeds (i.e., the accrued interest) will be repaid in the future.
The following entry represents this:
Cash
816,000
Interest Payable
Bonds Payable
16,000
800,000
32,000
16,000
48,000
Extinguishment of Liabilities
Under FASB Statement No. 125 a liability is considered extinguished for financial
reporting purposes if either of the following occurs:
1. The debtor pays the creditor and is relieved of its obligation for the liability. This
payment may take place at maturity, or prior to maturity by recall or by
reacquisition.
2. The debtor is released legally from being the primary obligor under the liability,
either by law or by the creditor.
Call Provisions allow a company to recall the debt issue at a prestated percentage of the
face value prior to the maturity date.
When a long-term non-interest bearing note is exchanged solely for cash, the note
is assumed to have a present value equal to the cash proceeds.
The difference between the cash proceeds and the face value of the note is
recorded as a discount and amortized over the life of the note by the effective
interest method.
The effective (implicit) interest rate is the rate that equates the future value on the
present value.
Example: Company issues a 3-year non-interest bearing note with a face value of
$8,000 and receives 5,694.24 in proceeds.
Cash
Discounts on Notes Payable
Notes Payable
5,694.24
2,305.76
8,000
683.31
683.31
The note is recorded at its present value at the time of issuance by discounting
the maturity value using the incremental interest rate of the borrower.
Interest expense is recorded over the life of the note using the effective
interest method.
The difference between cash proceeds and the present value of the note is
recorded as unearned revenue and revenue is recognized over the life of the
contract using appropriate revenue recognition criteria.
The notes is recorded at the fair value of the property, goods, or services, or
the fair value of the note, whichever is more reliable.
If neither of these fair values is determinable, the note is recorded at its
present value by discounting the future cash flow(s) using the incremental
interest rate of the borrower.
The note receivable is recorded at the fair value of the property, goods, or services
or the fair value of the note whichever is more reliable.
If neither of these values is reliable, the note is recorded at its present value by
using borrowers incremental interest rate.