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# ACCT Chapter 10 Condensed (Day 1 and 2).docx

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Northeastern University

Accounting

ACCT 1201

Ronen Gal-or

Spring

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Chapter 10 Condensed (Day 1 and 2)
I. Characteristics of Bonds
II. Bonds Sold at Par
III. Bonds Sold at a Discount
a. Straight-Line Amortization
b. Effective-Interest Amortization
IV. Bond Sold at a Premium
V. Early Retirement of Debt
VI. Times Interest Earned Ratio
VII. Debt-to-Equity Ratio
I. Characteristics of Bonds - Issued to raise money for long-term purposes
Terminology
A. Bond Principal, Par Value, Maturity Value or Face Value – the amount (a)
payable at the maturity of the bond and (b) on which the periodic cash interest
payments are computed.
B. Stated (interest) rate, Contract (interest) rate, or Coupon (interest) rate – the rate
of cash interest per period stated in the bond contract.
C. Cash Interest Payment = Bond Principal * Stated rate
D. Market (interest) rate, Effective (interest) rate or Yield - the rate of interest
currently being demanded by creditors to compensate them for the risks related to
bonds (Specifically Default Risk)
E. Default risk - the probability that a bond issuer will not be able to meet the
requirements specified in the indenture
Moody’s and Standard & Poor’s (agencies that evaluate default risk) use letter ratings
to specify the quality of a bond
Investment grade – bonds with ratings above Baa/BBB are investment grade
Junk bonds – bonds with ratings below that level are speculative.
http://www.cbsnews.com/8301-505123_162-57324258/penn-state-scandal-the-financial-fallout/
http://www.bloomberg.com/news/2011-06-13/greece-s-long-term-rating-cut-to-ccc-by-s-p-on-
outlook-for-restructuring.html
F. Indenture – bond contract that specifies the legal provisions of a bond issue’
provisions include:
1. Maturity Date
2. Stated Rate
3. Date of each interest payment (annual, semi-annual, etc)
4. Conversion Privileges
1 5. Covenants designed to protect the creditors (reported in notes to the financial
statements):
i. Limitations on new debt that the company might issue in the future
ii. Limitations on the payment of dividends
iii. Requirements for minimums of certain accounting ratios
Types of Bonds
A. Debenture – an unsecured bond; no assets are specifically pledged to guarantee
repayment
B. Secured bond – specific assets are pledged as a guarantee of repayment at maturity
C. Callable bond – may be called for early retirement at the option of the issuer
D. Convertible bond – may be converted to other securities of the issuer (usually
common stock)
II. Bonds Sold at Par (stated rate = market rate)
Eg: On January 1, 2009, $800,000, 5-year, bonds with a contract rate of 8% payable annually
were issued for the present value of the bond payments when the effective rate of interest was
8%.
1/1/2009 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013
Interest Payment 1 Interest Payment 2 Interest Payment 3 Interest Payment 4 Interest Payment 5
$800,000*8% $800,000*8% $800,000*8% $800,000*8% $800,000*8%
$ 64,000 $ 64,000 $ 64,000 $ 64,000 $ 64,000
Principal Payment
$ 800,000
PresentValue =?
Present value of a bond = sum of (1) present value of the principal (a single payment) and (2)
present value of the interest payments (an annuity) =
$800,000 X 0.6805832 = $544,466.60
$64,000 X 3.99271 = $255,533.40
$800,000
Prepare the journal entry to record the issuance (sale) of the bonds:
Prepare the journal entry to record the first payment of interest on 12/31/2009:
2 Note: Under the matching concept, interest expense incurred but not paid must be accrued with
an adjusting entry… If the interest payment was on 1/1/2010 instead of 12/31/2009:
Prepare the journal entry to record the settlement of the debt on 12/31/2013:
What if interest were semi-annual?
Eg: On January 1, 2009, $800,000, 5-year, bonds with a contract rate of 8% payable semi-
annually were issued for the present value of the bond payments when the effective rate of
interest was 8%.
1/1/2009 6/30/2009 12/31/2009 6/30/2010 12/31/2010 6/30/2011 12/31/2011 6/30/2012 12/31/2012 6/30/2013 12/31/2013
Interest Payment 1 Interest Payment 2 Interest Payment 3 Interest Payment 4 Interest Payment 5 Interest Payment 6 Interest Payment 7 Interest Payment 8 Interest Payment 9 Interest Payment 10
$800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12 $800,000*8% *6/12
$ 32,000 $ 32,000 $ 32,000 $ 32,000 $ 32,000$ 32,000$ 32,000$ 32,000$ 32,000$ 32,000

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