1
Bond issues
1 Factors to consider
1 Face value of the debt
2 Actual money obtained
3 Length of time that money is borrowed
4 Market interest rate - Interest rate is yield to maturity
5 Coupon rate on the bond issue – coupons are intermediate payments
2 Result is a present value calculation
1 Par (face value) (coupon rate = interest rate)
2 Discounts (coupon rate < interest rate)
3 Premium (coupon rate > interest rate)
3 Bond payment structures
1 Single payment of borrowing plus accrued interest at maturity
1 Zero coupon bond
2 Interest accrued as expense each year
3 Large balloon payment at maturity
4 Reported book value follows PV formula
2 Regular interest payments and payment of borrowing at maturity
1 Typical corporate bond
2 Coupon payments until maturity
3 Principal repayment at maturity
4 Reported book value follows PV formula
3 Floating rate debt and payment of borrowing at maturity
1 Coupon payments until maturity
2 Coupon rate is reset to new market rate every period
3 Principal repayment at maturity
4 Book value of bond stays at par value
4 Installment repayments of borrowing at specific times
1 Interest payments each period
2 Principal repayments at regular times
Bonds issued at par (coupon rate = interest rate or c = r)
1 Issue
Cash Par
Bond payable Par
2 Interest expense (could be an adjusting entry)
Interest expense rPar (r = c)
Interest payable cPar
3 Interest payment
Interest payable cPar
Cash cPar
4 Year before maturity
Bond payable Par
Curr portion of B/P Par
5 Payment
Curr portion of B/P Par
Cash Par
Bonds issued at discount (coupon rate < interest rate or c < r))
1 Issue
Cash Par-Disc
Bond discount Disc
Bond payable Par
2 Interest expense (could be an adjusting entry)
Interest expense r(Par-Disc)
Bond discount r(Par-Disc)-cPar
Interest payable cPar
3 Amount of the discount changes every period
4 Interest payment
Interest payable cPar
Cash cPar
Bonds issued at premium (coupon rate > interest rate or c > r))
1 Issue
Cash Par+Prem
Bond premium Prem
Bond payable Par
2 Interest expense (could be an adjusting entry)
Interest expense r(Par+Prem)
Bond premium r(Par+Prem)-cPar
Interest payable cPar
3 Amount of the premium changes every period
4 Interest payment
Interest payable cPar
Cash cPar
Floating rate debt
1 Issue
Cash Par
Bond payable Par
2 Interest expense
Interest expense rPar
Interest payable rPar
3 Interest expense (at new rate r’)
Interest expense r’Par
Interest payable r’Par
Early Retirement (Extinguishment)
1 Could lead to a gain or loss
2 May be called if rates fall
3 May be bought at market price if rates rise
4 Considered an extraordinary item
Call at 105
Bond Payable 100
Loss 5+x
Cash 105
Disc x
Troubled debt restructuring- Impact on notes or debt payable
1 Borrower cannot make normal payments
2 Response
1 Interest and principal payments can be stretched out
2 Interest and principal payments can be reduced
3 Can be a settlement for cash, assets or equity
3 Settlement (borrower)
1 Entry
Note payable
Interest payable
Loss (ordinary)or Gain (extraordinary)
Asset
4 Modification of terms
1 Restructure the loan
2 Calculate undiscounted sum of future expected cash flows
3 Include already accrued interest payable
1 Calculate new present value using old interest rate
2 Put new payable on books
3 Compare undiscounted cash flows to original obligation
4 If undiscounted cash flows exceed original obligation
1 Entry
Note payable
Interest payable
Restructured note payable
5 If undiscounted cash flows less than original obligation
1 Entry
Note payable
Interest payable
Restructured note payable
Gain on restructuring (extraordinary)
Conversion of debt to equity
1 Considered an extraordinary item
Bond payable Book value
Common stock Market value
Gain on Extinguishment [Market value – book value]
Leases
1 Lessee (User of the asset in exchange for series of payments)
2 Lessor (Provider of the asset)
1 Through owning the asset used by lessee
2 Through financing asset owned by lessee
3 Financing is very specific (not like debt)
3 Leases types - lessee
1 Operating leases
2 Capital leases
3 Lessees and lessor both affected by type of lease used
It is a capital lease if:
1 Lease life is 75% or more of asset useful life (original lease only) or
2 PV of lease payments is 90% or more of market value or
3 Bargain purchase option or
4 Transfer of ownership
1 If any holds it is a purchase of the asset
2 If none hold it is a use of asset owned by someone else
Operating lease – Lessee
1 Treated like short-term usage of service (use of employee, electric)
2 Rent expense
1 Payments as required as interest
2 An operating expense unlike interest
3 Expense
Rent expense X
Lease liability X
4 Payment
Lease liability X
Cash X
Capital lease – Lessee
1 Treated like an acquisition of the asset
2 Treated like a debt issue with payments in accord with lease contract
1 Payments usually a mix of interest payments and reduction of lease obligation
2 Like installment borrowing
3 Capitalize asset as ownership with borrowing
Leased Asset X
Capital Lease Liability X
4 Improve the leased asset for use
Leasehold Improvements Z
Cash Z
5 Include current portion in CL
Leased Asset X
Long-Term Capital Lease Liability V
Current Portion X-V
6 Period expenses
1 Asset related amortization (depreciation) each period
Amortization Exp X/n
Accumulated Amort X/n
2 On any leasehold improvements
Amortization Exp Z/n
Accumulated Amort Z/n
3 Liability related interest each period
Interest Exp Y (use effective interst rate method)
Interest Payable Y
4 Payment
Interest Payable Y
Current Portion X-V
Cash Y+X-V
5 Aging (next portion becomes current)
Long-Term Capital Lease Liability W
Current Portion W
Comparison of operating & capital leases for the lessee
1 Over full period
1 Cost allocation issue
1 Total expense same
2 Total cash flow same
2 Income from operations higher for capital lease
3 CFO higher for capital lease
4 Interest expense higher for capital lease
5 Amortization (and depreciation) higher for capital lease
2 At beginning - expenses
1 Capital lease expenses more early, less later
2 Income from operations ? (depends on amortization)
3 Income from operations higher for capital lease (St-L)
4 Income lower for capital lease
5 Shareholders’ equity lower for capital lease
3 At beginning - balance sheet
1 Capital lease asset declines quicker than lease liability
2 Asset falls by straight line
3 Liability falls more slowly
4 More interest in early years as loan is largest
5 Asset – liability is negative
6 More debt
4 At beginning - cash flows
1 Payments are equal
2 More interest in early years as loan is largest
3 As loan is partially paid off
1 Less interest in payment
2 Increased payoffs of debt
4 Interest is an operating cash outflow
5 Debt repayment is a financing cash outflow
6 Capital lease allocates some cash outflow to financing
1 Shows higher operating cash
2 Shows lower financing cash
5 Reporting
1 Operating flows in notes (5 years + as of NOW)
2 Capital flows and PV of obligation in notes (5 years +)
3 Both full repayment and lease repayment due in current period
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