PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA CHAPTER 10 REPORTING AND INTERPRETING BONDS McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

10-2 CHARACTERISTICS OF BONDS PAYABLE Two types of cash payment in the bond contract: 1. Principal. 2. Cash interest payments. Bond Terms 1.Principal, par value and face value 2.Contract, stated, or coupon rate of interest 3.Market, yield, or effective- interest rate

10-3 REPORTING BOND TRANSACTIONS = < > = < >

10-4 BONDS ISSUED AT PAR On January 1, 2014, AT&T issues $100,000 in bonds having 10% annual stated rate of interest. The bonds mature in 2 years and interest is paid semiannually. The market rate is 10% annually. This bond is issued at a par. On January 1, 2014, AT&T issues $100,000 in bonds having 10% annual stated rate of interest. The bonds mature in 2 years and interest is paid semiannually. The market rate is 10% annually. This bond is issued at a par. ==

10-5 BONDS ISSUED AT PAR Here is the entry made every six months to record the interest payment. Here is the entry to record the maturity of the bonds.

10-6 BONDS ISSUED AT DISCOUNT On January 1, 2014, AT&T issues $100,000 in bonds having a 10% annual stated rate of interest. The bonds mature in 2 years (Dec. 31, 2015) and interest is paid semiannually. The annual market rate of interest is 12%. This bond is issued at a discount. On January 1, 2014, AT&T issues $100,000 in bonds having a 10% annual stated rate of interest. The bonds mature in 2 years (Dec. 31, 2015) and interest is paid semiannually. The annual market rate of interest is 12%. This bond is issued at a discount. <<

10-7 BONDS ISSUED AT DISCOUNT The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) First, compute the present value of the principal. Market rate of 12% ÷ 2 interest periods per year = 6% Bond term of 2 years × 2 periods per year = 4 periods Market rate of 12% ÷ 2 interest periods per year = 6% Bond term of 2 years × 2 periods per year = 4 periods

10-8 BONDS ISSUED AT DISCOUNT Now, compute the present value of the interest. The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) Market rate of 12% ÷ 2 interest periods per year = 6% Bond term of 2 years × 2 periods per year = 4 periods Market rate of 12% ÷ 2 interest periods per year = 6% Bond term of 2 years × 2 periods per year = 4 periods

10-9 BONDS ISSUED AT DISCOUNT Finally, determine the issue price of the bond. The $96,536 is less than the face amount of $100,000, so the bonds are issued at a discount of $3,464. The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity)

10-10 BONDS ISSUED AT DISCOUNT This is a contra-liability account that appears in the liability section of the balance sheet. Here is the journal entry to record the bonds issued at a discount.

10-11 BONDS ISSUED AT DISCOUNT The discount will be over the 2-year life of the bonds. The discount will be amortized over the 2-year life of the bonds. Two methods of amortization are commonly used: Straight-line Effective-interest

10-12 REPORTING INTEREST EXPENSE: STRAIGHT-LINE AMORTIZATION Identify the amount of the bond discount. Identify the amount of the bond discount. Divide the bond discount by the number of interest periods. Divide the bond discount by the number of interest periods. Include the discount amortization amount as part of the periodic interest expense entry. Include the discount amortization amount as part of the periodic interest expense entry. The discount will be reduced to zero by the maturity date. The discount will be reduced to zero by the maturity date. Identify the amount of the bond discount. Identify the amount of the bond discount. Divide the bond discount by the number of interest periods. Divide the bond discount by the number of interest periods. Include the discount amortization amount as part of the periodic interest expense entry. Include the discount amortization amount as part of the periodic interest expense entry. The discount will be reduced to zero by the maturity date. The discount will be reduced to zero by the maturity date.

10-13 AT&T issued their bonds on Jan. 1, The discount was $3,464. The bonds have a 2-year maturity and $5,000 interest is paid semiannually. Compute the periodic discount amortization using the straight-line method. AT&T issued their bonds on Jan. 1, The discount was $3,464. The bonds have a 2-year maturity and $5,000 interest is paid semiannually. Compute the periodic discount amortization using the straight-line method. REPORTING INTEREST EXPENSE: STRAIGHT-LINE AMORTIZATION

10-14 REPORTING INTEREST EXPENSE: STRAIGHT-LINE AMORTIZATION As the discount is amortized, the carrying amount of the bonds increases.

10-15 REPORTING INTEREST EXPENSE: STRAIGHT-LINE AMORTIZATION An amortization table illustrates the interest payment, interest expense, discount amortization, unamortized discount balance, and the carrying value of the bond for each interest payment period over the life of the bond.

10-16 REPORTING INTEREST EXPENSE: EFFECTIVE-INTEREST AMORTIZATION The effective interest method is the theoretically preferred method. The effective interest method is the theoretically preferred method. Compute interest expense by multiplying the current unpaid balance times the market rate of interest. Compute interest expense by multiplying the current unpaid balance times the market rate of interest. The discount amortization is the difference between the calculated interest expense and the cash paid (or accrued) for interest. The discount amortization is the difference between the calculated interest expense and the cash paid (or accrued) for interest. The effective interest method is the theoretically preferred method. The effective interest method is the theoretically preferred method. Compute interest expense by multiplying the current unpaid balance times the market rate of interest. Compute interest expense by multiplying the current unpaid balance times the market rate of interest. The discount amortization is the difference between the calculated interest expense and the cash paid (or accrued) for interest. The discount amortization is the difference between the calculated interest expense and the cash paid (or accrued) for interest.

10-17 REPORTING INTEREST EXPENSE: EFFECTIVE-INTEREST AMORTIZATION AT&T issued their bonds on Jan. 1, The issue price was $96,536. The bonds have a 2-year maturity and $5,000 interest is paid semiannually. Compute the periodic discount amortization using the effective interest method. AT&T issued their bonds on Jan. 1, The issue price was $96,536. The bonds have a 2-year maturity and $5,000 interest is paid semiannually. Compute the periodic discount amortization using the effective interest method. Unpaid Balance × Effective Interest Rate × n / 12 $96,536 × 12% × 6 / 12 = $5,792 Unpaid Balance × Effective Interest Rate × n / 12 $96,536 × 12% × 6 / 12 = $5,792

10-18 REPORTING INTEREST EXPENSE: EFFECTIVE-INTEREST AMORTIZATION As the discount is amortized, the carrying amount of the bonds increases.

10-19 REPORTING INTEREST EXPENSE: EFFECTIVE-INTEREST AMORTIZATION Notice that for the effective-interest method, the amount of interest expense and discount amortization varies each period, unlike under the straight-line method where these were the same each period. *

10-20 BONDS ISSUED AT PREMIUM On January 1, 2014, AT&T issues $100,000 in bonds having a 10% annual stated rate of interest. The bonds mature in 2 years (Dec. 31, 2015) and interest is paid semiannually. The annual market rate of interest is 8%. This bond is issued at a premium. On January 1, 2014, AT&T issues $100,000 in bonds having a 10% annual stated rate of interest. The bonds mature in 2 years (Dec. 31, 2015) and interest is paid semiannually. The annual market rate of interest is 8%. This bond is issued at a premium. > >

10-21 BONDS ISSUED AT PREMIUM The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) First, compute the present value of the principal. Market rate of 8% ÷ 2 interest periods per year = 4% Bond term of 2 years × 2 periods per year = 4 periods Market rate of 8% ÷ 2 interest periods per year = 4% Bond term of 2 years × 2 periods per year = 4 periods

10-22 BONDS ISSUED AT PREMIUM Now, compute the present value of the interest. The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) Market rate of 8% ÷ 2 interest periods per year = 4% Bond term of 2 years × 2 periods per year = 4 periods Market rate of 8% ÷ 2 interest periods per year = 4% Bond term of 2 years × 2 periods per year = 4 periods

10-23 BONDS ISSUED AT PREMIUM Finally, determine the issue price of the bond. The $103,630 is greater than the face amount of $100,000, so the bonds are issued at a premium of $3,630. The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity) The issue price of a bond is composed of the present value of two items: Principal (a single amount) Interest (an annuity)

10-24 BONDS ISSUED AT PREMIUM The premium will be over the 2-year life of the bonds. The premium will be amortized over the 2-year life of the bonds.

10-25 REPORTING INTEREST EXPENSE: STRAIGHT-LINE AMORTIZATION An amortization table illustrates the interest payment, interest expense, premium amortization, unamortized premium balance, and the carrying value of the bond for each interest payment period over the life of the bond.

10-26 REPORTING INTEREST EXPENSE: STRAIGHT-LINE AMORTIZATION Here is the journal entry to record the payment of interest and the premium amortization every six months using the straight-line amortization method.

10-27 * REPORTING INTEREST EXPENSE: EFFECTIVE-INTEREST AMORTIZATION Notice that for the effective-interest method, the amount of interest expense and premium amortization varies each period, unlike under the straight-line method where these were the same each period.

10-28 REPORTING INTEREST EXPENSE: EFFECTIVE-INTEREST AMORTIZATION Here is the journal entry to record the payment of interest and the premium amortization for the six months ending on June 30, 2014.

10-29 EARLY RETIREMENT OF DEBT Occasionally, the issuing company will call (repay early) some or all of its bonds. Occasionally, the issuing company will call (repay early) some or all of its bonds. Gains/losses are calculated by comparing the bond call amount with the book value of the bond. Gains/losses are calculated by comparing the bond call amount with the book value of the bond. Occasionally, the issuing company will call (repay early) some or all of its bonds. Occasionally, the issuing company will call (repay early) some or all of its bonds. Gains/losses are calculated by comparing the bond call amount with the book value of the bond. Gains/losses are calculated by comparing the bond call amount with the book value of the bond. Book Value > Retirement Price = Gain Book Value < Retirement Price = Loss

10-30 END OF CHAPTER 10