1 Bond Accounting

8/3/2019 1 Bond Accounting

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BOND ACCOUNTING

LECTURE 7

BY

HINA SAMDANI


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What are bonds?

Bonds are a form of interest bearing notes payable.

They are issued by corporations, governmentalagencies.

When companies need large funds of long-termcapital to finance some capital intensive projectsthey resort to options such as Shares or Bonds alsoknown a bonds payable in the accounting books.

Bonds are basically Debt instruments and are usedto break up a large loan into small bits.


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Cont.. Bonds are issued for a long time period

usually 30 -40 years.

Bonds are transferable i.e. can be sold to otherinvestors.

Bonds are often referred to as the fixed

income investments as they pay specific rateof interest coupon rate on the value of

investment.


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ADVANTAGES OF BOND

FINANCING

Stockholders control is not affected.

Bond holders do not have voting rights, so currentowners retain full control of the company.

Tax saving results.

Bond tax is deductible for tax purposes.

Earning per share may be higher.

No additional shares of common stock are issued


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Effects on Earning per Share Stocks vs. Bonds

PLAN A PLAN B

Issue stock Issue bonds

Income before interest

& tax $ 1500000 $1500000

Interest (12%x5000000) - 600000

Income before tax 1500000 900000

Tax expense (30%) 450000 270000

Net income 1050000 630000

Outstanding shares 300000 100000

Earnings per share $3.50 $6.30


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BOND CHARACTERISTICS

Face Value:

Amount of principal the issuer pay at maturity date.

Interest Rate:

Referred as Stated Rate is the rate used to determine theamount of cash interest the borrower pays and theinvestor receives. Paid semiannually.

Bond Indenture:

The legal document in which the terms of the bondissue are set forth.


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CONT..

Call option:

- Can be called back at any time but at a

higher price. Convertible Bonds:

Can be converted into a specified number of

shares at the option of the bondholder.

Bond sinking fund:

A fund created to ensure the investor of the

ability of the corporation to pay back its

loans.


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TYPES OF BONDS

1. SECURED & UNSECURED BONDS:

SECURED BONDS: Have specific asset of the issuer

pledged as collateral for the bonds.

A bond secured by real estate is called a Mortgage

Bond.

A bond secured by specific assets set aside to retire the

bond is called Sinking Fund Bond.UNSECURED BONDS: Are issued against the general

credit of the borrower.

These bonds are called Debenture Bonds.


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CONT..

2. TERM & SERIAL BONDS:

TERM BONDS: Bonds that mature at a single specified futuredare.

SERIAL BONDS: Bonds that mature in installments.

3. REGISTERED & BEARER BONDS:

REGISTERED BONDS: Bonds that issue in the name of theowner.

Interest payments made by checks.

BEARER BONDS: Bonds not registered.

Holders must send coupons to receive interest payments.


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CONT.

4. CONVERTIBLE & CALLABLE BODS:

CONVERTIBLE BONDS: Bonds that can be converted

into common stock at the bond holders option.CALLABLE BONDS: Bonds subject to retirement at a

stated dollar amount prior to maturity at the optionof the issuer.

5. Junk bonds: Bonds issued by companies with a lessercredit rating. Usually pay very high interest.


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ISSUING PROCEDURES

State laws grant the power to issue bonds.

Approval required by board of directors.

BOD must stipulate: Number of bond to be issued

Face value Interest rate.

Bond indenture prepared

Bond certificates printed

Include:

Name of the issuer Face value

Interest rate

Maturity date.

Generally sold through investment company specialized in bond selling.


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MARKET PRICE OF A BOND

Bond prices are quoted as a percentage of their

face value or maturity value.

The primary factors which determine the market

value of a bond are:

The relationship of the bonds coupon rate to the

market interest rate of similar investments (Market

rate of interest). The amount to be received.

The length of time till the bond matures.

The investor confidence in the company.


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CONT.

When ever the price of the bond is more than

its maturity value (face value) it is said to be

selling at Premium. When ever the price of the bond is less than

its maturity value (face value) it is said to be

selling at Discount.


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ACCOUNTING FOR BOND ISSUES

Bonds may be issued at:

Face Value

Below Face Value (at a discount)

Above Face Value (at a premium)


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ISSUING BONDS AT FACE VALUE

On January 1 Devor issues 1,000, 10 years, 9%,$1,000 bonds.

Entry to record sale:

Jan 1 Cash 1,000,000

Bonds payable 1,000,000

To record sale of bonds at value.

Reported in long-term liability section ofbalance sheet.


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CONT..

Interest paid semi annually.

Entry to record interest payment:

July 1 Bond interest expense 45,000

Cash 45,000

To record payment of bond interest.

($1,000,000 x 9% x 6/12)

Adjusting entry on December 31:

Dec 31 Bond interest expense 45,000

Bond interest payable 45,000

To accrue bond interest.


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ISSUING BONDS ON DISCOUNT ORPREMIUM

MARKET BONDS SELL

INTEREST RATE AT

BONDINTEREST

RATE10%

8%

10%

12%

PREMIUM

FACE VALUE

DISCOUNT


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ISSUING BONDS AT A DISCOUNT

On January 1, 2002, Candlestick Inc.sells $100,000, 5-year, 10% bonds for

$92,639. Entry:

Jan 1 Cash 92,639

Discount on bonds payable 7,361Bonds payable 100,000

To record sale of bonds at a discount.


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CONT..

Balance sheet presentation:

Long-term liabilities:

Bonds payable $100,000

Less: discount on bonds payable 7,361 $92,639

COST OF BORROWING:

Semiannual interest payments

($100,000 x 10% x = $5,000; $5000x10) $50,000

Add: Bond discount (100,000-$92,639) 7,361

Total cost of borrowing $57,361


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CONT

COST OF BORROWING:

Principal at maturity $100,000

Semiannual interest payments( $5000x10) 50,000

Cash to be paid to be paid to bondholders 150,000Cash received from bondholders 92,639



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ISSUING BONDS AT A PREMIUM

On January 1, 2002, Candlestick Inc. sells

$100,000, 5-year, 10% bonds for $108,111.

Entry:Jan 1 Cash 108,111

Bonds payable 100,000

Premium on bonds payable 8,111To record sale of bonds at a premium.


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CONT..

Balance sheet presentation:

Long-term liabilities:

Bonds payable $100,000

Add: Premium on bonds payable 8,111 $108,111

COST OF BORROWING:

Semiannual interest payments

($100,000 x 10% x = $5,000; $5000x10) $50,000

Less: Bond premium ($108,111-$100,000) 8,111



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CONT

COST OF BORROWING:

Principal at maturity $100,000

Semiannual interest payments( $5000x10) 50,000

Cash to be paid to be paid to bondholders 150,000Cash received from bondholders 108,111



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ACCOUNTING FOR BOND

RETIREMENT

REDEEMING BONDS AT MATURITY:

On January 1, 2002, Candlestick Inc. sells $100,000,

5-year, 10% bonds at face value.


Cash 100,000

To record redemption of bond at maturity.


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CONVERTING BONDS INTO

COMMON STOCK

Assume that on January 1 Saunders Associatesconverts $100,000 bonds sold at face valueinto 2000 shares of $10 par value commonstock.


Common stock 20,000Paid in capital in excess of par value 80,000

To record bond conversion.

Documents

1 Bond Accounting