1. Bonds Chapter 13 from Financial Accounting

2. Bonds  A form of interest bearing note  Requires periodic interest payments  The face amount must be repaid at the maturity date  Bondholders are creditors of the issuing corporation

3. Terminology  Bond Indenture Contract with bondholders  Principal Face value of each bond

4. Types of Bonds  Term Bonds  Serial Bonds  Convertible bonds  Callable bonds  Debenture bonds

5. Present Value & Bonds  Price that buyers are willing to pay for the bonds dependent upon The face amount of the bonds Periodic interest to be paid Market rate of interest

6. Interest  Coupon rate – Rate of interest stated on the bonds  Market or effective rate Interest determined by market conditions

7. Interest rates  If the Market rate = coupon rate BONDS sells at FACE  If the market rate > Coupon rate BONDS sells BELOW Face DISCOUNT  If the market rate < coupon rate BONDS sells ABOVE face PREMIUM

8. Accounting for Bonds  Bonds issued at face value CashDR Bonds payableCR Interest expDR CashCR

9. Bonds at Discount  Steps: Compute the PV of the face amount Computer the PV of the interest payments Add the amounts in the first two steps Face amount – selling price = discount

10. Bonds at Discount  Entry: CashDR DiscountDR Bonds payableCR  Example: Corp sells $100,000 of 5 years bonds with a coupon rate of interest of 12% and market rate of interest of 13%. Interest is $6,000 is paid semiannually.

11. Example 3: Selling Price of Bonds PV of FACE ( 100,000, r = 13%/2, p = 5 X 2) $100,000 X.53273 = $53,273 PV of Interest pay ($6,000, r = 6.5%, p =10) $6,000 X 7.1883 = 43,130 Selling price of bonds 96,403

12. Example 3 Face value$100,000 Selling price 96,403 Discount 3,597 ENTRY: Cash96,403 Discount 3,597 Bonds payable100,000

13. Example 4: PV( $200,000, r 11%/2, p = 10) $200,000 X.58543 = $117,086 PV ( $10,000, r 11%/2, p=10) $10,000 X 7.53763 = 75,376 Selling price 192,462 Face 200,000 Discount 7,538

14. Example 4 Entry: Cash 192,462 Discount 7,538 Bonds payable 200,000

15. Amortization of Bond Discount  Two methods Straight line method Discount amortized = Discount/# of interest payments Effective interest method

16. Example 5  Discount amortized = 3594/10 = $359.4  Interest expense 6,360 Discount360 Cash 6,000

17. Example 6 Interest exp 3780 discount 780 cash 3000 Discount amortized = 7800/10 = $780

18. Bonds issued at Premium  Same as discount  Face amount – selling price = premium  Entry: Cash DR Bonds payable CR Premium CR

19. Example 3  Corporation sells $100,000 of 5 year bond with a coupon rate of interest of 12% and market rate of interest of 11%. Interest of $6,000 is paid semiannually.

20. Example 3 PV ( $100,000, r=11%/2, p =10) $100,000 X.58543 = $58,543 PV($6,000, r=11%/2, p=10) $6,000 X 7.53763 = 45,226 Selling price 103,769 Face 100,000 Premium 3,769

21. Example 3  Cash103,769  Premium 3,769  Bonds payable 100,000

22. Example 4  PV( $200,000, p=10, r =5%)  $200,000 *.61391= $122,782  PV($11,000, p =10, r=%)  $11,000 * 7.72174 = 89,939  Selling price 207,721  Face 200,000  Premium 7,721

23. Entry  Cash207,721  Premium 7,721  Bonds payable 200,000

24. Premium Amortization  Straight line method Amortized = Premium/# of interest payment Example 5: Amortized = 3594/10 = $360 Interest exp 5640 Premium 360 Cash6,000

25. Example 6  Amortized = 7800/10 = $780  Interest exp 7020  Premium 780  Cash 7800

26. Homework  EX 13-8  EX 13-9  Ex 13-11  EX 13-12  EX 13-13

27. Update  Wed 12/3: Review  Test Three Differential analysis Capital investment analysis Cash flows Bonds Multiple choice/ short problems  Monday 12/8 Homework due Test three  Wednesday 12/10 Review for final examination  Monday 12/15 Final Examination