Textbook Notes (280,000)
US (110,000)
NU (1,000)
ACCT (100)
Chapter 10

ACCT 1201 Chapter Notes - Chapter 10: Premium Bond, Interest Expense, Effective Interest Rate


Department
Accounting
Course Code
ACCT 1201
Professor
Ganesh Krishnamoorthy
Chapter
10

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Accounting Chapter 10 03/21/2014
Capital Structure is the mixture of debt and equity a company uses
to finance its operations.
Characteristics Of Bonds Payable
Why Do Corporations want to issue bonds instead of shares?
Stockholders maintain control.
Interest expense is tax deductible whereas dividends paid on stock
are not cash deductible.
The impact on earnings is positive
Disadvantages of issuing bonds
Risk of bankruptcy
Negative impact on cash flows
A bond usually requires the payment of interest over its life with
repayment of principal on the maturity date
The bond principal is the amount that is payable at the maturity
date and is the amount interests payments are computed with.
oAlso called the par value, face amount, and maturity value
A bond always specifies a stated rate of interest and the timing of
periodic cash interest payments usually annually or semiannually
oThe selling price of a bond odes not affect the periodic cash
payment of interest.
Unsecured (debenture) bond No assets are pledged as a
guarantee of repayment at maturity.
Secured Bond specific assets are pledged as a guarantee of
repayment at maturity
Callable Bond may be called for early retirement by the issuer.
Convertible Bond the bond may be converted to common stock of
the issuer
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Bond Indenture bond contract
oCan require restrictions on the company as the amount of
more debt they can issue or requirements to maintain key
accounting ratios.
Trustee A trustee duties are to ascertain whether the issuing
company has fulfilled all provisions of the bond indenture
Reporting Bond Transactions
Coupon Rate the interest times the principal
To compute the present value of a bond you compute the present
value of the principal ( a single payment) and the present value of the
interest payments (an annuity) and add the two amounts
Market Interest Rate is the current rate of interest on a debt when
incurred
This is the result of creditors demanding a certain rate of interest to
compensate them for the risks related to bonds
The present value of a bond may be the same as par above par or
below par
Bond Premium the market interest rate of the bond is less than
the coupon interest rate
oWhen a bond is paying more than what the market is
demanding than creditors are willing to buy it a premium
Bond Discount the market interest rate is higher than the coupon
interest rate of the bond.
oWhen a bond is paying less that what the market is
demanding than creditors will not buy it unless the price is
reduced (discounted)
When a bond is issued at par the issuer received cash equal to its par
value
When a bond is issued at a discount the issuer receives less cash than
the par value
When a bond is issued at a premium the issuer receives less cash than
the par value.
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Corporations do not care whether the bond is issued at par, at a
discount, or at a premium because bonds are always priced to
provide the market rate of interest.
Bonds Issued At Par
Bonds sell at their par value when buyers are willing to invest in them at the
interest rate stated in the bond contract.
The amount of money a corporation receives when it sells bonds is
the present value of the future cash flows associated with them.
oWhen a bond is issued a corporations agrees to make two
payments in the future
A single payment of the principal (Ex 100,000)
An annuity of 5,000 payable twice a year for two years
oWhen the effective rate of interest equals the stated rate of
interest the present value of the future cash flows associated
with a bond always equals the bond’s par value amount
A bond’s selling price is determined by the present value of its future
cash flows not the par value
Therefore for a bond with a single payment of 100,000
That pays 10% interest for two years semiannually
oThe present value equals
o(Single payment)100,000 x 0.8227 = 82,270
o(Annuity) 5,000 x 3.5460 = 17,730
Total = 100,000
Therefore this is reported as
oCash (+A) -----------100,000
Bond Payable (+L)---------100,000
Bonds may pay interest each month, each quarter, each half-year or each
year
X
Reporting Interest Expense on Bonds Issued At Par
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