Upload File

chapter 10 · irwin/mcgraw-hill © the mcgraw-hill companies, inc., 2001 $ irwin/mcgraw-hill © the...

  • Home
  • Documents
  • Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,
of 60 /60
© The McGraw-Hill Companies, Inc., 2001 Irwin/McGraw-Hill Chapter 10 Reporting and Interpreting Bonds

Upload: lamlien

Post on 24-Apr-2018

312 views

Category:

Documents


10 download

Report

Embed Size (px)

TRANSCRIPT

Page 1: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Chapter 10

Reporting and Interpreting Bonds

Page 2: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Business Background

The mixture of debt and equity used to finance a company’s operations is called the capital

structure:

Debt - funds from creditors

Equity - funds from owners

Page 3: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Significant debt needs of a company are often filled

by issuing bonds.

Significant debt needs of a company are often filled

by issuing bonds.

Business BackgroundCapital Structure - Bonds

Bonds Cash

Page 4: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Business Background

Bonds can be traded on

established exchanges that

provide liquidity to

bondholders.

Bonds can be traded on

established exchanges that

provide liquidityliquidity to

bondholders.

As liquidity increases . . .

. . . Cost of borrowing decreases.

Page 5: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Business Background

Advantages of bonds:• Bonds are debt, not equity, so the

ownership and control of the company are not diluted.

• Interest expense is tax-deductible.• The low interest rates on bonds

allow for positive financial leverage.

Advantages of bonds:• Bonds are debt, not equity, so the

ownership and control of the company are not diluted.

• Interest expense is tax-deductible.• The low interest rates on bonds

allow for positive financial leverage.

Page 6: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Business Background

Disadvantages of bonds:• The scheduled interest

payments are legal obligations and must be paid each period.

• A single, large principal payment is required at the maturity date.

Disadvantages of bonds:• The scheduled interest

payments are legal obligations and must be paid each period.

• A single, large principal payment is required at the maturity date.

Page 7: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Key Ratio Analysis

The debt-equity ratio is an important measure of the balance between debt and

equity.

High debt-equity ratios indicate more leverage and risk.

Debt/equity ratio = Total liabilities Owners' equity

Debt/equity ratio = Total liabilities Owners' equity

Page 8: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Characteristics of Bonds Payable

Company Issuing Bonds

Company Issuing Bonds

$ Bond Issue Price $Investor Buying Bonds

Investor Buying Bonds

Bond Certificate

At Bond Issuance Date

Bonds payable are long-term debtfor the issuing company.

Page 9: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Characteristics of Bonds Payable

Company Issuing Bonds

Company Issuing Bonds

PeriodicInterest Payments$ $

Investor Buying Bonds

Investor Buying Bonds

Face Value Payment at End of

Bond Term$ $

Page 10: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

1. Face Value = Maturity or Par Value, Principal2. Maturity Date3. Stated Interest Rate4. Interest Payment Dates5. Bond Date

Characteristics of Bonds Payable

Other Factors:6. Market Interest Rate7. Issue Date

BOND PAYABLE

Face Value $1,000 Interest 10%6/30 & 12/31

Maturity Date 1/1/10Bond Date 1/1/01

Page 11: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Characteristics of Bonds Payable

• When issuing bonds, potential buyers of the bonds are given a prospectus.

• The company’s bonds are issued to investors through an underwriter.

• The trustee makes sure the issuer fulfills all of the provisions of the bond indenture.

• When issuing bonds, potential buyers of the bonds are given a prospectus.

• The company’s bonds are issued to investors through an underwriter.

• The trustee makes sure the issuer fulfills all of the provisions of the bond indenture.

Page 12: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Bond Classifications

• Debenture bondsNot secured with the pledge of a specific asset.

• Callable bondsMay be retired and repaid (called) at any time at the option

of the issuer.• Redeemable bonds

May be turned in at any time for repayment at the option of the bondholder.

• Convertible bondsMay be exchanged for other securities of the issuer

(usually shares of common stock) at the option of the bondholder.

•• Debenture bondsDebenture bondsNot secured with the pledge of a specific asset.

•• Callable bondsCallable bondsMay be retired and repaid (called) at any time at the option

of the issuer.•• Redeemable bondsRedeemable bonds

May be turned in at any time for repayment at the option of the bondholder.

•• Convertible bondsConvertible bondsMay be exchanged for other securities of the issuer

(usually shares of common stock) at the option of the bondholder.

Page 13: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

• Senior Debt receives preference over other creditors in the event of bankruptcy or default.

• Subordinated Debt is riskier than senior debt.

•• Senior Debt Senior Debt receives preference over other creditors in the event of bankruptcy or default.

•• Subordinated Debt Subordinated Debt is riskier than senior debt.

Bond Classifications

Page 14: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Measuring Bonds Payable and Interest Expense

Present Value of the Principal (a single payment)+ Present Value of the Interest Payments (an annuity) = Issue Price of the Bond

Present Value of the Principal (a single payment)+ Present Value of the Interest Payments (an annuity) = Issue Price of the Bond

The issue price of the bond is determined by the market, based on the time value of money.

The interest rate used to compute the present value is the market interest ratemarket interest rate.

Page 15: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Measuring Bonds Payable and Interest Expense

The stated ratestated rate is only used to compute the periodic interest payments.

Interest = Principal × Stated Rate × TimeInterest = Principal × Stated Rate × Time

Page 16: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Bond Premium and Discounts

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value There is no differenceRate Rate Price of the Bond to account for.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond discount.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond premium.

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value There is no differenceRate Rate Price of the Bond to account for.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond discount.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond premium.

=

>

<

>

<

=

Page 17: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 6% annually. The bonds mature in 10 years and interest is paid semiannually.

The market rate is 8% annually.

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 6% annually. The bonds mature in 10 years and interest is paid semiannually.

The market rate is 8% annually.

Are Harrah’s bonds issued at par, at a discount, or at a premium?

Page 18: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 6%

annually. The bonds mature in 10 years and interest is paid semiannually. The

market rate is 8% annually.

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 6%

annually. The bonds mature in 10 years and interest is paid semiannually. The

market rate is 8% annually.

Issuing Bonds

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond discount.

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond discount.< <

Page 19: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 6%

annually. The bonds mature in 10 years and interest is paid semiannually. The

market rate is 8% annually.

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 6%

annually. The bonds mature in 10 years and interest is paid semiannually. The

market rate is 8% annually.

Compute the issue price of Harrah’s bonds.

Page 20: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueSingle Amount = Principal × Factor

Issuing Bonds

!Compute the present value of the principal.

Use the present value of a single amount table to find the

appropriate factor.

Use the present value of a single amount table to find the

appropriate factor.

Page 21: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueSingle Amount = Principal × Factor, i=4.0%

Issuing Bonds

!Compute the present value of the principal.

Use the market rate of 8% to determine present value. Interest is

paid semiannually, so the rate is i=4% (8% ÷ 2 interest periods per year).

Use the market rate of 8% to determine present value. Interest is

paid semiannually, so the rate is i=4% (8% ÷ 2 interest periods per year).

Page 22: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueSingle Amount = Principal × Factor, i=4.0%, n=20

Issuing Bonds

!Compute the present value of the principal.

Though the maturity period is 10 years, there are 2 interest periods per year. For the present value computation, use n=20

(10 years × 2 periods per year).

Though the maturity period is 10 years, there are 2 interest periods per year. For the present value computation, use n=20

(10 years × 2 periods per year).

Page 23: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds

!Compute the present value of the principal.

Present ValueSingle Amount = Principal × Factor, i=4.0%, n=20

= 1,000,000$ × 0.4564 = 456,400$

Page 24: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueAnnuity = Payment × Factor

Issuing Bonds

"Compute the present value of the interest payments.

The interest payment is computed as:

$1,000,000 × 6% × 6/12

= $30,000

The interest payment is computed as:

$1,000,000 × 6% × 6/12

= $30,000

Page 25: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 30,000$

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 30,000$

Issuing Bonds

"Compute the present value of the interest payments.

Use the same i=4.0% and n=20 used for the present value of the principal,

but use the present value of an annuity table.

Use the same i=4.0% and n=20 used for the present value of the principal,

but use the present value of an annuity table.

Page 26: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds

"Compute the present value of the interest payments.

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 30,000$ × 13.5903 = 407,709$

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 30,000$ × 13.5903 = 407,709$

Now, the issue price of the bonds can be computed.

Now, the issue price of the bonds can be computed.

Page 27: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds

#Compute the issue price of the bonds.

456,400$ Present Va lue of the Principa l + 407,709 Present Va lue of the Interest

= 864,109$ Present Va lue of the Bonds

456,400$ Present Va lue of the Principa l + 407,709 Present Va lue of the Interest

= 864,109$ Present Va lue of the Bonds

Page 28: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

456,400$ Present Va lue of the Principa l + 407,709 Present Va lue of the Interest

= 864,109$ Present Va lue of the Bonds

456,400$ Present Va lue of the Principa l + 407,709 Present Va lue of the Interest

= 864,109$ Present Va lue of the Bonds

Issuing Bonds

#Compute the issue price of the bonds.

The $864,109 is less than the face amount of

$1,000,000, so the bonds are issued at a discount of

$135,891.

The $864,109 is less than the face amount of

$1,000,000, so the bonds are issued at a discount of

$135,891.

Page 29: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

GENERAL JOURNAL Page 97Date Description Debit Credit

May 1 Cash 864,109Discount on Bonds Payable 135,891 Bonds Payable 1,000,000to record issuance of bonds

Recording BondsIssued at a Discount

$Prepare the journal entry to record the issuance of the bonds.

This is a contra-liability account and appears in the liability section of the balance sheet.

This is a contra-liability account and appears in the liability section of the balance sheet.

Page 30: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Harrah'sPartial Balance Sheet

At May 1, 2001

Long-Term LiabilitiesBonds Payable, 6% 1,000,000$ Due April 30, 2011 Less: Bond Discount (135,891) Total L-T Liabilities 864,109$

Bonds Issued at a DiscountFinancial Statement Presentation

The discount The discount will be will be

amortizedamortizedover the 10over the 10--

year life of the year life of the bonds.bonds.

Page 31: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Harrah'sPartial Balance Sheet

At May 1, 2001

Long-Term LiabilitiesBonds Payable, 6% 1,000,000$ Due April 30, 2011 Less: Bond Discount (135,891) Total L-T Liabilities 864,109$

Harrah'sPartial Balance Sheet

At May 1, 2001

Long-Term LiabilitiesBonds Payable, 6% 1,000,000$ Due April 30, 2011 Less: Bond Discount (135,891) Total L-T Liabilities 864,109$

Bonds Issued at a DiscountFinancial Statement Presentation

Two methods Two methods of amortization of amortization are commonly are commonly

used:used:StraightStraight--lineline

ororInterest MethodInterest Method

Page 32: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Straight-Line Amortization of Bond Discount

!Identify the amount of the bond discount.

"Divide the bond discount by the number of interest periods.

#Include the discount amortization amount as part of the periodic interest expense entry.The discount will be reduced to

zero by the maturity date.

!Identify the amount of the bond discount.

"Divide the bond discount by the number of interest periods.

#Include the discount amortization amount as part of the periodic interest expense entry.The discount will be reduced to

zero by the maturity date.

Page 33: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Straight-Line Amortization of Bond Discount

Harrah’s issued their bonds on May 1, 2001. The discount was $135,891. The bonds have a 10-year maturity

and $30,000 interest is paid semiannually.

Compute the periodic discount amortization using the straight-line method.

Harrah’s issued their bonds on May 1, 2001. The discount was $135,891. The bonds have a 10-year maturity

and $30,000 interest is paid semiannually.

Compute the periodic discount amortization using the straight-line method.

Page 34: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Harrah’s issued their bonds on May 1, 2001. The discount was $135,891. The bonds have a 10-year maturity

and $30,000 interest is paid semiannually.

Compute the periodic discount amortization using the straight-line method.

Harrah’s issued their bonds on May 1, 2001. The discount was $135,891. The bonds have a 10-year maturity

and $30,000 interest is paid semiannually.

Compute the periodic discount amortization using the straight-line method.

Straight-Line Amortization of Bond Discount

Discount Total Number ofAmortization = Discount ÷ Interest Periods

Discount Total Number ofAmortization = Discount ÷ Interest Periods

Page 35: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Harrah’s issued their bonds on May 1, 2001. The discount was $135,891. The bonds have a 10-year maturity

and $30,000 interest is paid semiannually.

Compute the periodic discount amortization using the straight-line method.

Harrah’s issued their bonds on May 1, 2001. The discount was $135,891. The bonds have a 10-year maturity

and $30,000 interest is paid semiannually.

Compute the periodic discount amortization using the straight-line method.

Straight-Line Amortization of Bond Discount

Discount Total Number ofAmortization = Discount ÷ Interest Periods

= 135,891$ ÷ 20

= 6,795$ per period (rounded)

Discount Total Number ofAmortization = Discount ÷ Interest Periods

= 135,891$ ÷ 20

= 6,795$ per period (rounded)

Page 36: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Straight-Line Amortization of Bond Discount

Prepare the journal entry to record the payment of interest and the discount amortization for the six months ending on November 1, 2001.

Prepare the journal entry to record the payment of interest and the discount amortization for the six months ending on November 1, 2001.

GENERAL JOURNAL Page 123Date Description Debit Credit

Nov. 1 Interest Expense 36,795 Discount on Bonds Payable 6,795 Cash 30,000To record payment of interest

Page 37: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Bonds Issued at a DiscountFinancial Statement Presentation

As the discount is

amortized, the carrying

amount of the bonds

increases.

Harrah'sPartial Balance SheetAt November 1, 2001

Long-Term LiabilitiesBonds Payable, 6% 1,000,000$ Due April 30, 2011 Less: Bond Discount (129,096) Total L-T Liabilities 870,904$

Harrah'sPartial Balance SheetAt November 1, 2001

Long-Term LiabilitiesBonds Payable, 6% 1,000,000$ Due April 30, 2011 Less: Bond Discount (129,096) Total L-T Liabilities 870,904$

Page 38: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Zero Coupon Bonds

• Zero coupon bonds do not pay periodic interest.

• Because there is no interest annuity . . .

• This is called a deep discount deep discount bondbond.

PV of the Principal = Issue Price of the BondsPV of the Principal = Issue Price of the Bonds

Page 39: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds at a Premium

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value There is no differenceRate Rate Price of the Bond to account for.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond discount.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond premium.

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value There is no differenceRate Rate Price of the Bond to account for.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond discount.

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond premium.

=

>

<

>

<

=

Page 40: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds at a Premium

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 10% annually. The bonds mature in 10 years and interest is

paid semiannually. The market rate is 8% annually.

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 10% annually. The bonds mature in 10 years and interest is

paid semiannually. The market rate is 8% annually.

Are Harrah’s bonds issued at par, at a discount, or at a premium?

Page 41: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 10% annually. The bonds mature in 10 years and interest is

paid semiannually. The market rate is 8% annually.

On May 1, 2001, Harrah’s issues $1,000,000 in bonds having a stated rate of 10% annually. The bonds mature in 10 years and interest is

paid semiannually. The market rate is 8% annually.

Issuing Bonds at a Premium

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond premium.

Interest Bond Accounting forRates Price the Difference

Stated Market Bond Par Value The difference is accountedRate Rate Price of the Bond for as a bond premium.> >

Let’s compute the issue price of the bonds.

Page 42: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueSingle Amount = Principal × FactorPresent ValueSingle Amount = Principal × Factor

Issuing Bonds at a Premium

!Compute the present value of the principal.

Use the present value of a single amount table to find the

appropriate factor.

Use the present value of a single amount table to find the

appropriate factor.

Page 43: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueSingle Amount = Principal × Factor, i=4.0%Present ValueSingle Amount = Principal × Factor, i=4.0%

Issuing Bonds at a Premium

!Compute the present value of the principal.

Use the market rate of 8% to determine present value. Interest is paid

semiannually, so the rate is i=4.0% (8% ÷ 2 interest periods per year).

Use the market rate of 8% to determine present value. Interest is paid

semiannually, so the rate is i=4.0% (8% ÷ 2 interest periods per year).

Page 44: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueSingle Amount = Principal × Factor, i=4.0% , n=20Present ValueSingle Amount = Principal × Factor, i=4.0% , n=20

Issuing Bonds at a Premium

!Compute the present value of the principal.

The maturity period is 10 years, there are 2 interest periods per year. For the present value computation, use n=20

(10 years × 2 periods).

The maturity period is 10 years, there are 2 interest periods per year. For the present value computation, use n=20

(10 years × 2 periods).

Page 45: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds at a Premium

!Compute the present value of the principal.

Present ValueSingle Amount = Principal × Factor, i=4.0% , n=20

= 1,000,000$ × 0.4564 = 456,400$

Present ValueSingle Amount = Principal × Factor, i=4.0% , n=20

= 1,000,000$ × 0.4564 = 456,400$

Next, we compute the present value of the interest payments.Next, we compute the present value of the interest payments.

Page 46: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueAnnuity = Payment × Factor

Present ValueAnnuity = Payment × Factor

Issuing Bonds at a Premium

"Compute the present value of the interest payments.

The interest payment is computed as:

$1,000,000 × 10% × 6/12

= $50,000

The interest payment is computed as:

$1,000,000 × 10% × 6/12

= $50,000

Page 47: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 50,000$

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 50,000$

Issuing Bonds at a Premium

"Compute the present value of the interest payments.

Use the same i=4.0% and n=20 that were used to compute the present

value of the principal. Now, however, the factor comes from the present value of an annuity table.

Use the same i=4.0% and n=20 that were used to compute the present

value of the principal. Now, however, the factor comes from the present value of an annuity table.

Page 48: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Issuing Bonds at a Premium

"Compute the present value of the interest payments.

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 50,000$ × 13.5903 = 679,515$

Present ValueAnnuity = Payment × Factor, i=4.0% , n=20

= 50,000$ × 13.5903 = 679,515$

Now, the issue price of the bonds can be computed.

Now, the issue price of the bonds can be computed.

Page 49: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

456,400$ Present Va lue of the Principa l + 679,515 Present Va lue of the Interest

= 1,135,915$ Present Va lue of the Bonds

456,400$ Present Va lue of the Principa l + 679,515 Present Va lue of the Interest

= 1,135,915$ Present Va lue of the Bonds

Issuing Bonds at a Premium

#Compute the issue price of the bonds.

The $1,135,915 is greater than the face amount of $1,000,000, so the bonds are issued at a premium of

$135,915.

The $1,135,915 is greater than the face amount of $1,000,000, so the bonds are issued at a premium of

$135,915.

Page 50: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

GENERAL JOURNAL Page 97Date Description Debit Credit

May 1 Cash 1,135,915 Bonds Payable 1,000,000 Premium on Bonds Payable 135,915

Issuing Bonds at a Premium

$Prepare the journal entry to record the issuance of the bonds.

This is called an adjunct account and appears in the liability section.This is called an adjunct account

and appears in the liability section.

Page 51: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Harrah'sPartial Balance Sheet

At May 1, 2001

Long-Term LiabilitiesBonds Payable, 10% 1,000,000$ Due April 30, 2011Add: Bond Premium 135,915 Total L-T Liabilities 1,135,915$

Harrah'sPartial Balance Sheet

At May 1, 2001

Long-Term LiabilitiesBonds Payable, 10% 1,000,000$ Due April 30, 2011Add: Bond Premium 135,915 Total L-T Liabilities 1,135,915$

Bonds Issued at a PremiumFinancial Statement Presentation

The The premium premium

will be will be amortizedamortized

over the 10over the 10--year life of year life of the bonds.the bonds.

Page 52: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Effective-Interest Amortization of Bond Discounts and Premiums

Bond Carrying Value × Market RateBond Carrying Value × Market Rate

The effective-interest method computes interest as:

Principal amount of the bonds less any unamortized discount or plus any unamortized premium.

Principal amount of the bonds less any unamortized discount or plus any unamortized premium.

Page 53: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Effective-Interest Amortization of Bond Discounts and Premiums

This is the same market rate used to determine the

present value of the bond.

This is the same market rate This is the same market rate used to determine the used to determine the

present value of the bond.present value of the bond.

Bond Carrying Value × Market RateBond Carrying Value × Market Rate

The effective-interest method computes interest as:

Page 54: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Effective-Interest Method

Recall our first example of Harrah’s. On May 1, 2001, the company issues $1,000,000 in bonds having a

stated rate of 6% annually. The bonds mature in 10 years and interest is paid semiannually. The

market rate is 8% annually.

Recall our first example of Harrah’s. On May 1, 2001, the company issues $1,000,000 in bonds having a

stated rate of 6% annually. The bonds mature in 10 years and interest is paid semiannually. The

market rate is 8% annually.

GENERAL JOURNAL Page 97Date Description Debit Credit

May 1 Cash 864,109Discount on Bonds Payable 135,891 Bonds Payable 1,000,000to record issuance of bonds

Page 55: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Effective-Interest Method

Principal amount of bonds 1,000,000$ Less: unamortized discount (135,891) Bond Carrying Value 864,109 Market interest rate 4.00%Interest expense - 11/1/01 34,564$

Interest is paid semi-annually, so the market rate

is 8% ÷ 2 = 4%.

Interest is paid semi-annually, so the market rate

is 8% ÷ 2 = 4%.

The cash paid to bond holders if $30,000 ($1,000,000 × 3%)

The cash paid to bond holders if $30,000 ($1,000,000 × 3%)

Page 56: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Effective-Interest Method

The journal entry to record the first interest payment is:

GENERAL JOURNAL Page 123Date Description Debit Credit

Nov. 1 Interest Expense 34,564 Discount on Bonds Payable 4,564 Cash 30,000To record payment of interest

Page 57: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Effective-Interest Method

The new bond carrying value of the next interest payment period is:

Principal amount of bonds 1,000,000$ Less: unamortized discount (131,327) Bond Carrying Value 868,673

Unamortized discount 135,891$ Less: amount amortized (4,564) New unamortized discount 131,327

Page 58: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Understanding Alternative Amortization Methods

• Effective-interest method of amortization is preferred by GAAP.

• Straight-line amortization may be used if it is not materially different from effective interest amortization.

• Effective-interest method of amortization is preferred by GAAP.

• Straight-line amortization may be used if it is not materially different from effective interest amortization.

Page 59: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Early Retirement of Debt

• Occasionally, the issuing company will call (repay early) some or all of its bonds.

• Gains/losses incurred as a result of retiring bonds, should be reported as an extraordinary item on the income statement.

• Occasionally, the issuing company will callcall (repay early) some or all of its bonds.

• Gains/losses incurred as a result of retiring bonds, should be reported as an extraordinary itemextraordinary item on the income statement.

Page 60: Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

End of Chapter 10


McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, All Rights Reserved
12-1 McGraw-Hill/Irwin
11-1 McGraw-Hill/Irwin
Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2004
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All
McGraw-Hill/Irwin ©2005 The McGraw-Hill Companies, All rights reserved ©2005 The McGraw-Hill Companies, All rights reserved McGraw-Hill/Irwin
© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
McGraw-Hill/Irwin ©2005 The McGraw-Hill Companies, All rights reserved McGraw-Hill/Irwin
© 2002 McGraw-Hill Companies, Inc., McGraw-Hill/Irwin
Irwin / McGraw-Hill
McGraw-Hill/Irwin Copyright © 2004, The McGraw-Hill Companies
Local Marketing in Mature Markets Chapter Eight. Irwin/McGraw-Hill ©The McGraw-Hill Companies,, Inc., 2000 Irwin/McGraw-Hill ©The McGraw-Hill Companies,,
12-1 McGraw-Hill/Irwin © 2012 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All
McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All
Chapter 11 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Chapter 11 Reporting and Interpreting Owners’ Equity. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,
McGraw-Hill/Irwin©2007, The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin©2007, The McGraw-Hill Companies, All Rights Reserved Essentials
Relevant Costs for Decision Making - NELY BACHSIN BLOG · PDF fileChapter Thirteen . McGraw-Hill/Irwin ... McGraw-Hill/Irwin Copyright © 2008, ... McGraw-Hill/Irwin Copyright © 2008,
McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved
© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin
1 2-1 McGraw-Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc.,
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc
McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill
McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies
© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved
4 1 Irwin/McGraw Hill
#14-1 McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights
1 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Seven McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc.,
Chapter Ten LocalMarketing in Emerging Markets Irwin/McGraw-Hill ©The McGraw-Hill Companies,, Inc., 2000 Irwin/McGraw-Hill ©The McGraw-Hill Companies,,
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies,
© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin
10-1 McGraw-Hill/Irwin
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin