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ACC 311 Lecture Notes - Lecture 13: Accrued Interest, Relative Risk, Debenture

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apricotwoodchuck413

3 May 2018

School

University of Miami

Department

Accounting Business Administration

Course

Professor

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CHAPTER 14

A bond represents a promise to pay:

1. A sum of money at designated maturity date

2. Periodic interest at specified rate on maturity amount (face value)

Main Purpose: to borrow for long term when amount of capital needed is too large for

one lender to supply

Types of bonds:

● Secured (mortgage) bonds, unsecured (debenture) bonds, term, serial, callable

bonds; convertible, commodity-backed, deep-discount bonds; registered and

bearer (coupon) bonds; income and revenue bonds

The selling price of a bond issue is set by the supply and demand of buyers and

sellers, relative risk, market conditions and state of the economy.

● Interest rate = stated, coupon, nominal rate

○ Set by issuer of bond

○ Percentage of face value (par value, principal amount, maturity value)

● If bond sells for less than face value and interest rate is lower than market

rate/effective yield = DISCOUNT.

● If bond sells for more than face value and interest rate is higher than market

rate/effective yield = PREMIUM.

● Inverse relationship between market interest rate and price of bond

1. Bonds issued at par on interest date

a. Par value of $800,000, semi annual interest of 10%, 10 year bond.

b. January 1, 2017

i. Debit cash for $800,000

ii. Credit bonds payable $800,000

c. July 1, 2017 (first semiannual interest payment)

i. Debit interest expense $40,000

ii. Credit cash $40,000

d. Accrued interest expense at Dec 31, 2017 (year end)

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Document Summary

A bond represents a promise to pay: a sum of money at designated maturity date, periodic interest at specified rate on maturity amount (face value) Main purpose: to borrow for long term when amount of capital needed is too large for one lender to supply. Secured (mortgage) bonds, unsecured (debenture) bonds, term, serial, callable bonds; convertible, commodity-backed, deep-discount bonds; registered and bearer (coupon) bonds; income and revenue bonds. The selling price of a bond issue is set by the supply and demand of buyers and sellers, relative risk, market conditions and state of the economy. Percentage of face value (par value, principal amount, maturity value) If bond sells for less than face value and interest rate is lower than market rate/effective yield = discount. If bond sells for more than face value and interest rate is higher than market rate/effective yield = premium.

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Related Questions

TRUE OR FALSE?

1. Bondholders are crditors of the issuing corporation.

2. bondholders claims on the assets of the corporation rank aheadof stockholders

3. the prices of bonds are quoted as a percentage of the bonds'market value

4. when the market rate of interest is less than the contract ratefor a bond, the
bond will sell for a premium.

5. an equal stream of periodic payments is called an annuity.

6.one reason a dollar today is worth more than a dollar 1 year fromtoday is the time
value of money.

7. if the straight-line method of amortization is used, the amountof unamortization
premium on bonds payable will decrease as the bonds approachmaturity.

8. if the amount of a bond premium on an issued 11% 4-year,$100,000 bond is $12,928, the amiannual straight-line amortizationof the premium is $1,416.

9. The issue price of zero-coupon bonds is the present value oftheir face amount.

10. if sinking fund cash is used to purchase investments,thoseinvestments are
reported on the balance sheet as marketable securities.

11. callable bonds can be redeemed by the issuing corporation atthe fair market
price of the bonds.

12. if bonds of $1,000,000 with unamortized discount if $10,000 areredeemed at 98,
the gain on redemption of bonds is $10,000

13. Amortization is the allocation process of writing off bondpremiums and discounts to interest expense over the life of thebond issue.

14. the amortization of a premium on bonds payable decreses bondinterest expense.

15. the balance in premium on bonds payable should be reported as adeduction from bonds payable on the balance sheet.

Multiple Choice:
16. one potential advantage of financing corportations through theuse of bonds rather than common stock is
a.the interest on bonds must be paid when due
b.the corporation must pay the bonds at maturity
c.the interest expense is deductable for tax purposes by thecorporation
d.a higher earnings per share is guarenteed for existing commonshareholders

17. when the corporation issuing the bonds has the right torepurchase the bonds prior to the maturity date for a specificprice, the bonds are
a. convertible bonds
b.unsecured bonds
c.debenture bonds
d.callable bonds

18.the present value of $30,000 to be received in 2 years, at 12%compounded annually is (rounded to nearest dollar)
a. $23,916
b.$37,632
c.23,700
d.30,000

19. An unsecured bons is the same as a
a. debenture bond
b. zero coupon bond
c. term bond
d. bond indenture

20. if $1,000,000 of 8% bonds are issued at 102 1/2, the amount ofcash recieved from the sale is
a.$1,080,000
b.$975,000
c.$1,000,000
d.$1,025,000

21. A corporation issues for cash $1,000,000 of 8%,20-year bonds,interest payable annually, at a time when the market rate ofinterest is 7%. the straight-line method is adopted for theamortization of bond discount or premium. which of the following istrue?
a. the carrying amount increases from its amount at issuance dateto $1,000,000 at maturity.
b. the carrying amount decreases from its amount at issuance dateto $1,000,000 at maturity.
c.the amount of annual interest paid to bondholders increases overthe 20-year life of the bonds
d.the amount of annual interest expense decreases as the bondsapproach maturity.

22. When the market rate of interest was 11%, Waverly corporationissued $1,000,000,12%,8-year bonds that pay interest semiannually.the selling price of this bond issue was
a. $1,052,310
b. $1,154,387
c.$1,000,000
d.720,495

23. The journal entry a company records for the issuance of bondswhen the contract rate is less than the market rate would be
a.debit bonds payable, credit cash
b.debit cash and discount on bonds payable, credit bondspayable
c.debit cash, credit premium on bonds payable and bondspayable
d.debit cash, credit bonds payable

24. On januaray 1,2007 the kings corporation issued 10% bonds witha face value of $100,000. the bonds are sold for $96,000. The bondspay interest semiannually on june 30 and december 31 and thematuritydate is december 31,2011. kings records straight-lineamortization of the bond discount. the bond interest expense forthe year ended dec 31,2007 is
a. $9,200
b.$9,800
c.$10,400
d.$10,800

25.If the market rate of interest is 10%, a $10,000, 12%, 10-yearbond that pays interest semiannually would sell at an amount
a.less tha face value
b.equal to face valur
c.greater thand face value
d.that cannot be determined

26. the torrez corporation issue a $1,000, 10-year bonds, 8%,$1,000 bonds dated jan 1,2007 at 97. the journal entry to recordthe issuance will show a
a.credit to discount on bonds payable for $30,000
b.debit to cash of $1,000,000
c.credit to bonds payable for $1,000,000
d.credit to cash for $970,000

27.bonds with a face amount $1,000,000 are sold at 97. the entry torecord the issuance is
a.Cash $1,000,000
Premium on bonds payable $30,000
Bonds Payable &nbÃµns?x.?H?mnbsp;$970,000
b.Cash $970,000
Premium on bonds payable $30,000
bonds payable $1,000,000
c.Cash $970,000
Discount on bonds payable $30,000
Bonds payable $1,000,000
d.Cash $970,000
Bonds Payable $970,000

28. the cash and securities comprising a sinking fund establishedto redeem bonds at maturity in 2015 should be classified on thebalance sheet as
a.fixed asset
b.current asset
c.intangable assets
d.investments

29. when callable bonds are redeemed below carrying value
a. gain on redemption of bonds is credited
b.loss on redemption of bonds is debited
c.retained earnings is credited
d.retained earnings is debited

$488,000.

PLEASE BE SURE OF THE ANSWERS AND PROVIDE SOLUTION FOR EACH SOTHAT I CAN UNDERSTAND.

PLEASE ANSWER QUESTION A PART 1 and 2 QUESTION B Part 1 and 2and QUESTION C Part 1

Pleae complete it on excel or copy paste it from excel

A.

ClassCo sells Convertible Bond with warrant to convert intostock

Bond with face

$1,000

Face Rate

8.00%

Term

3

Yrs.

Market rate @ sale

8.50%

issued:

6/30/2018

maturity

6/30/2021

Interest paid annually

Bond sold for

996.00

Part 1) determine value received from sale, Discount orPremium?

Part 2) Prepare JE to record sale, use incremental

assume value of Bond in the known

and value of warrant is incremental

B.

ClassCo:

PE 12/31/2018

Fiscal = calendar Yr.

Net income: after tax

2000

shares:

Beginning:

505

3/1 issue

50

9/1 issue

60

Treasury Purchase 10/30

(24)

on 11/22, 3 for 1 split

Preferred dividends this year =

250

Part 1) Calculate EPS

Part 2) using "as if" compute EPS & dilutiveeffect of Convertible Bonds

issued 10 bonds , $1000 bonds issued prior yr., 6%, each bondwas convertible into 30 shares

40% tax rate for bonds

C.

NET Income:

4500

No preferred stock

Average # of Shares

2200

EPS =

2.045

Stock Options:

all full Yr.

# option shares

500

0ption price per share

$18

Market at PE being measured

$32

Part 1

Compute dilutive effect per share