BISK – CHAPTER 6



BISK – CHAPTER 6

BONDS

OVERVIEW

Issues:

• Held to Maturity

• Serial and Term Bonds

• Debenture Bonds

• Callable bonds

• Convertible bonds - for equity interests

Acquisition of a Bond & Interest Payment

• Premium and discount

Example of Bond Acquired at a Discount:

• Treasury Bills

• Corporate Bonds

Purchased Jan 1

Face value $100,000

Cost $ 96,000

Interest rate – 5% payable on maturity

Matures – in 1 year

Accrue for discount to bring cost to face value at maturity

Yield = 9%

| | | | | | | |

| | | | | | | | |Premium work the same way

o Premium reduces interest income

• Discounts increase interest income

• Book using effective interest method = Yield

Issues:

• Different year end and payment dates – uses bond dates

• Bonds sold between interest dates – use daily effective rates

Disclosures:

• Valuation on balance sheet with note reference

• Terms clearly set out in notes

Par Value – can happen, not often

Bond Issuance Costs

• Classification

• Amortize

Bond Retirement Issues:

• Legal terms – get releases on extinguishment

• Payment retires debt

• Extinguishment vs. Refunding

• Principal and Related amounts

• Extraordinary Item

Write off of bond issue costs, i.e. legal fees – will be same as premium and discount

o Straight line method

o Effective Interest method

o Amortization Tables

o Present Values

o Declining Principal

Convertible Bonds

• Part Debt – Part Equity

• Earnings per share diluted

• Induced Conversions

• Debt issues with detachable stock warrants

OH-01 (Example 1)

X buys at par on September 1, a 10%, $1,000 bond issued on June 1. Interest dates are June 1 and December 1.

Investment in Bonds

Interest Receivable (10% x $1,000 x 3 months/12 months) Cash

To record the purchase of bonds on September 1.

Cash (10% x $1,000 x 6/12) Interest Receivable

Interest Income

To record receipt of the interest proceeds on December 1.

6-5

1,000 25

50

1,025

25 25

OH-03 (MC #14)

During the year, Lake Co. issued 3,000 of its 9%, $1,000 face value bonds at 101 %. In connection with the sale of these bonds, Lake paid the following expenses:

Promotion costs

Engraving and printing Underwriters' commissions

$ 20,000 25,000 200,000

What amount should Lake record as bond issue costs to be amortized over the term of the bonds?

a. $0

b. $220,000

c. $225,000

$245,000 (11/92, PI, #37, amended, 3270)

6-7

OH-05

Amortization of Premiums, Discounts, and Bond Issue Costs

Amortization under effective interest method (for bond issue costs, premiums, and discounts).

Dollars

Amortization under straight-line method.

Time

Straight-Line Method

• Constant amount of amortization per period

Effective Interest Method

• Less amortization in the initial years

• More amortization in the latter years

0. Dollar amount of amortization always increases over the life of the bonds

6-9

OH-07 (MC #30)

Clay Corp. had $600,000 convertible 8% bonds outstanding at June 30. Each $1,000 bond was convertible into 10 shares of Clay's $50 par value common stock. On July 1, the interest was paid to bondholders, and the bonds were converted into common stock, which had a fair market value of $75 per share. The unamortized premium on these bonds was $12,000 at the date of conversion. Under the book value method, this conversion increased the following elements of the stockholders' equity section by:

Common stock

a. $300,000

b. $306,000

c. $450,000

d. $600,000

Additional

paid-in capital $312,000 $306,000 $162,000

$ 12,000 (11/91, PI, #37, amended, 2425)

OH-08 (MC #45)

Ray Corp. issued bonds with a face amount of $200,000. Each $1,000 bond contained 100 detachable stock warrants for shares of Ray's common stock. Total proceeds from the issue amounted to $240,000. The market value of each warrant was $2, and the market value of the bonds without the warrants was $196,000. The bonds were issued at a discount of:

a. $0

b. $ 678

c. $ 4,000

$33,898 (5/91, PI, #5, amended, 1023)

OH-06

Book Value Method

1. Remove carrying amount (book value) of bonds

2. Credit "Common Stock" for par value of common stock issued to effect conversion.

3. Credit "Additional Paid-In Capital" to balance transaction.

4. No gain or loss recognized on conversion.

5. Expenses Incurred in Connection With Conversion

Credit cash and reduce the amount of additional paid-in capital recognized-do not recognize as an expense.

Bonds Payable Premium

Cash

Common Stock APIC-CS (to balance)

100 Bonds Payable

10 Discount

3 Cash

40 Common Stock

67 APIC-CS (to balance)

100

10 3 40 47

OH-04 (MC #17)

On June 30, year 1, King Co. had outstanding 9°1o, $5,000,000 face value bonds maturing on June 30, year 6. Interest was payable semiannually every June 30 and December 31. On June 30, year 1, after amortization was recorded for the period, the unamortized bond premium and bond issue costs were $30,000 and $50,000, respectively. On that date, King acquired all its outstanding bonds on the open market at 98 and retired them. At June 30, year 1, what amount should King recognize as gain before income taxes on redemption of bonds?

a. $ 20,000

b. $ 80,000

c. $120,000

$180,000 (11/92, PI, #47, amended, 3280)

104

Premium

100

OH-02 (Exhibit 1)

Bond Premiums and Discounts

Amortize premium of 4 over the life of the bond

Face Value

100

Amortize discount of 4 over the life of the bond

Discount

96

The end chapter 6

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