Click to edit Master title style Bonds Payable

Click to edit Master title style Financing Corporations 15-1 A bond is simply a form of an interest-bearing note. Like a note, a bond requires periodic interest payments, and the face amount must be repaid at the maturity date.

Click to edit Master title style Bonds Payable  A corporation that issues bonds enters into a contract (called a bond indenture or trust indenture) with the bondholders.  Usually, the face value of each bond, called the principal, is $1,000 or a multiple of $1,000.  Interest on bonds may be payable annually, semiannually, or quarterly. Most pay interest semiannually.

Click to edit Master title style  When all bonds of an issue mature at the same time, they are called term bonds  If the maturity dates are spread over several dates, they are called serial bonds.  Bonds that may be exchanged for other securities are called convertible bonds.

Click to edit Master title style  Bonds issued on the basis of the general credit of the corporation are debenture bonds  Bonds that a corporation reserves the right to redeem before their maturity are called callable bonds. 15-2

Click to edit Master title style Pricing of Bonds Payable When a corporation issues bonds, the price that buyers are willing to pay depends upon three factors: 1.The face amount of the bonds, which is the amount due at the maturity date. 2.The periodic interest to be paid on the bonds. This is called the contract rate or the coupon rate. 3.The market or effective rate of interest.

Click to edit Master title style The market or effective rate of interest is determined by transactions between buyers and sellers of similar bonds. The market rate of interest is affected by a variety of factors, including: 1.investors assessment of current economic conditions, and 2.future expectations.

Click to edit Master title style MARKET RATE = CONTRACT RATE Selling price of bond = $1,000 $1,000 10% payable annually 15-2 If the contract rate equals the market rate of interest, the bonds will sell at their face amount.

Click to edit Master title style MARKET RATE > CONTRACT RATE Selling price of bond < $1,000 – Discount $1,000 10% payable annually 15-2 If the market rate is higher than the contract rate, the bonds will sell at a discount.

Click to edit Master title style MARKET < CONTRACT RATE Selling price of bond > $1,000 + Premium $1,000 10% payable annually 15-2 If the market rate is lower than the contract rate, the bonds will sell at a premium.

Click to edit Master title style On January 1, 2007, a corporation issues for cash $100,000 of 12%, five-year bonds; interest payable semiannual. The market rate of interest is 12% Issued $100,000 bonds payable at face amount. Bonds Payable Jan. 1Cash

Click to edit Master title style On June 30, an interest payment of $6,000 is made ($100,000 x.12 x 6/12) June 30Interest Expense Cash Paid six months’ interest on bonds.

Click to edit Master title style The bond matured on December 31, At this time, the corporation paid the face amount to the bondholder Cash Paid bond principal at maturity date. Dec. 31Bonds Payable

Click to edit Master title style 14 Since the payment of bonds normally involves a large amount of cash, a bond indenture may require that cash be periodically transferred into a special cash fund, called a sinking fund, over the life of the bond issue. 15-4

Click to edit Master title style 15 Bond Redemption 15-4 A corporation may call or redeem bonds before they mature. Callable bonds can be redeemed by the issuing corporation within the period of time and the price stated in the bond indenture. Normally, the call price is above the face value.

Click to edit Master title style 16 Bonds may be purchased either directly from the issuing corporation or through an organized bond exchange. Prices for bonds are quoted as a percentage of the face amount. Accounting for Bond Investments 15-5

Click to edit Master title style On April 2, 2007, an investor purchases a $1,000 Lewis Company bond at 102 plus a brokerage fee of $5.30 and accrued interest of $ Cash Apr.2Investment in Lewis Co. Bonds Interest Revenue10 20 Invested in a Lewis Company bond.

Click to edit Master title style 18 Cash Apr.2Investment in Lewis Co. Bonds Interest Revenue10 20 Invested in a Lewis Company bond. 57 On April 2, 2007, an investor purchases a $1,000 Lewis Company bond at 102 plus a brokerage fee of $5.30 and accrued interest of $ Note that the brokerage fee is added to the cost of the investment.

Click to edit Master title style On July 1, 2007, Crenshaw Inc. purchases $50,000 of 8% bonds of Deitz Corporation due in 8 3/4 years. The effective interest rate is 11%. The purchase price is $41,706 plus interest of $1,000 accrued from April 1, 2007 ($50,000 x 8% x 3/12). Extended Illustration for Crenshaw, Inc.

Click to edit Master title style Interest Revenue Cash Purchased investment in bonds, plus accrued interest. July1Investment in Deitz Corp. Bonds The entry to record the investment is as follows:

Click to edit Master title style Crenshaw, Inc. received semiannual interest for April 1 to October 1 ($50,000 x 8% x 6/12) Interest Revenue Received semiannual interest for April 1 to October 1. Oct.1Cash

Click to edit Master title style Adjusting entry for interest accrued from October 1 to December 31 ($50,000 x 8% x 3/12) Interest Revenue Dec.31Interest Receivable Adjusting entry for interest accrued from October 1 to December 31.

Click to edit Master title style 23 Balance Sheet of a Corporation 72 (Continued) 15-6

Click to edit Master title style 24 Balance Sheet of a Corporation 15-6 (Concluded) 73

Click to edit Master title style Held-to-Maturity Securities Investments in bonds or other debt securities that management intends to hold to their maturity are called held-to-maturity securities.

Click to edit Master title style 26  Such securities are classified as long-term investments under the caption Investments  These investments are reported at their cost less any amortized premium or plus any amortized discount.  The market (fair) value of the bond investment should be disclosed, either on the face of the balance sheet or in an accompanying note. Balance Sheet Presentation of Bond Investments