Financial accounting

• Bonds


  A form of interest-bearing notes payable issued by companies, universities, and governmental agencies
• Bonds


  • Sold in small denominations (usually €1,000 or multiples of €1,000)
  • When a company issues bonds, it is borrowing money
  • The person who buys the bonds (the bondholder) is lending money
• Types of Bonds


  • Secured bonds
  • Unsecured bonds
• Secured bonds


  Have specific assets of issuer pledged as collateral for bonds
• Unsecured bonds


  Are issued against general credit of borrower
• Additional Types of Bonds


  • Convertible bonds
  • Callable bonds
• Convertible bonds


  Can be converted into ordinary shares at bondholder's option
• Callable bonds


  Can be redeemed (bought back), by issuing company, at a stated currency amount prior to maturity
• Issuing Procedures


  1. Government laws grant companies power to issue bonds

  2. Board of directors and shareholders usually must approve bond issues

  3. Board of directors must stipulate number of bonds to be authorized, total face value, and contractual interest rate

  4. Terms of bond are set forth in a legal document called a bond indenture
• Bond certificate


  • Issued to investor
  • Provides name of the issuer, face value, contractual interest rate, and maturity date
• Face value


  Principal due at maturity
• Maturity date


  Date final payment is due
• Contractual interest rate


  Annual rate used to determine cash interest paid, also referred to as the stated rate

  
• Bondholders can sell their bonds at any time on national securities exchanges
• Bonds prices are quoted as a percentage of face value
• Company makes journal entries only when it issues or buys back bonds, or when bondholders convert bonds into ordinary shares
• Market information for bonds


  • Issuer
  • Contractual Interest Rate
  • Maturity
  • Close
  • Yield

  
• Current market price (present value) of a bond


  A function of three factors: amounts to be received, length of time until amounts are received, and market rate of interest

  
• Determining the Price of a Bond

  1. Present value of €100,000 received in 5 years

  2. Present value of €9,000 received annually for 5 years

  
• A company records bond transactions when it issues (sells) or redeems (buys back) bonds, or when bondholders convert bonds into ordinary shares
• Bonds may be issued at face value, below face value (discount), or above face value (premium)
• Bond prices are quoted as a percentage of face value
• Market interest rate


  The rate investors demand for loaning funds
• Issuing Bonds at Face Value


  Cash

  Bonds Payable

  Interest Expense

  Interest Payable
• Interest Rates and Bond Prices


  As interest rates rise, bond prices fall

  As interest rates fall, bond prices rise

  
• Issuing Bonds at a Discount


  Cash

  Bonds Payable
• Bond discount


  Allocated to expense in each period

  Increases amount of interest expense reported each period

  Amount of interest expense reported each period will exceed contractual amount paid

  As discount is amortized, its balance declines

  Carrying value of bonds will increase, until at maturity carrying value of bonds equals their face amount
• Issuing Bonds at a Premium


  Cash

  Bonds Payable
• Bond premium


  The borrower is not required to pay the bond premium at the maturity date of the bonds

  The bond premium is considered to be a reduction in the cost of borrowing
• The total cost of borrowing for bonds issued at a discount is the annual interest payments plus the bond discount
• The total cost of borrowing for bonds issued at a premium is the annual interest payments less the bond premium
• Bonds issued at a premium


  The borrower is not required to pay the bond premium at the maturity date of the bonds. Thus, the bond premium is considered to be a reduction in the cost of borrowing.
• Total cost of borrowing - bonds issued at a premium


  1. Annual interest payments (€100,000 × 10% = €10,000; €10,000 × 5)

  2. Less: Bond premium (€102,000 − €100,000)

  
• Total cost of borrowing for bonds issued at a premium is €48,000
• Alternative computation of total cost of borrowing - bonds issued at a premium


  1. Principal interest €100,000

  2. Annual interest payments (€10,000 × 5)

  3. Cash to be paid to bondholders

  4. Less: Cash received from bondholders

  
• Bond premium amortization


  • Allocated to expense in each period
  • Decreases amount of interest expense reported each period
  • Amount of interest expense reported each period will be less than contractual amount paid
  • As premium is amortized, its balance declines
  • Carrying value of bonds will decrease, until at maturity carrying value of bonds equals their face amount
• Amortization of bond premium

  • Illustration 11.13

  
• Issuing bonds at a premium - journal entry

  1. Cash

  2. Bonds Payable
• Reporting bonds issued at a premium on statement of financial position


  • Non-current liabilities
  • Bonds payable

  
• Redeeming bonds at maturity - journal entry


  1. Bonds Payable

  2. Cash