How do you calc the PV of a bond? And record it?
eg, 1/1/Y1 issued $100K par 5% 5 yr bond, when mkt rate was 8%. Int due 12/31
= (face value * PV of $1 @ mkt rate)
+ (int due @ stated rate * PV of ordinary annuity @ mkt rate)
= (100K * .68058) + (5000 * 3.99271) = 88022
Dr Cash 88022
Dr Disc 11978
Bond Py 100,000
How do you record the payment of bond interest?
Cash out is the stated bond interest pymt
Then, calc the discount based on the cash pd for the bond * effective mkt rate
eg, Cash out on bond was 88022 when mkt rate was 8%, stated coupon pymt is $5000 (100K bond @ stated 5%, annual pymts)
Dr. Int Exp 7042 (bond BV 88022 * .08 effective int rate)
Cr Cash 5000 (stated bond int pymt)
Cr Disc 2042 (diff between cash and int exp)
What rates would we choose for this example?
Bex Inc. issues a 7% coupon, $100,000 bond maturing in 10 years. The bond pays interest SEMIANNUALLY, and market rates at the time of issuance are 8%.
PV of $1 at 7% for 10 periods 0.5083
PV of $1 at 8% for 10 periods 0.4632
PV of $1 at 3.5% for 20 periods 0.5026
PV of $1 at 4% for 20 periods 0.4564
PV of an annuity of $1 at 7% for 10 periods 7.0236
PV of an annuity of $1 at 8% for 10 periods 6.7101
PV of an annuity of $1 at 3.5% for 20 periods 14.2124
PV of an annuity of $1 at 4% for 20 periods 13.5903
PV of $1 @ 4% for 20 periods for the bond
PV of an annuity of $1 @ 4% for 20 periods
B/c this is a semiannual bond, the relevant factors are the ones for 4% rate for 20 semiannual periods
PV of interest: 3500 * 13.5903 = 47,566
PV of principle: 100K * 0.4564 = 45,640
** Notice the interest calc is divided by 2 b/c it is semiannual
👉 “Just because something is called ‘interest’ doesn’t mean it goes to interest expense.”
How are these diff type of interest and related costs classified and reported on the FS?
- pension cost interest
- amortization of discount of a note
- deferred compensation plan interest
- int incurred to finance a software development for internal use
- Pension cost interest
→ Included in net periodic pension cost (operating)
→ ❌ NOT interest expense - Amortization of discount (note/bond)
→ Included in interest expense
→ (increases interest expense over time) - Deferred compensation plan interest
→ Included in compensation expense
→ ❌ NOT interest expense - Interest – internal-use software
→ Capitalized as part of the software asset
→ ❌ NOT expensed as interest
🧠 Clean mental shortcut (this is the real key)
Ask yourself:
👉 “Is this actually financing… or part of something else?”
• True borrowing cost? → Interest expense
• Part of another system? → Goes with that system
• Pension → pension cost
• Comp plan → compensation expense
• Software build → capitalize
What does a $50K bond issued at 98 mean? How do you calc its value?
means it was issued at 98% of face value
= 50K * .98 = 49K, so 1K = disc
Dr Cash 49,000
Dr. Disc 1,000
Cr Bonds Payable 50,000
What “issued at 98” really means
- Price is quoted as a % of face value
- So:
$50K × 98% = $49K issue price
- That $49K IS the present value of the bond
Record the JE for the following bond, incl both the issuance JE and subsequent pymts
$100K bond @ 8% pd semiannually issued at 104, mkt rate 6%
Issuance JE
Dr Cash 104,000
Cr Bonds Payable 100,000
Cr Premium on Bond 4,000
First Int Pymt (6mo later)
Dr Int Exp (effective int: 104K * 6% / 2)
Dr Premium on Bond Py 880 (4000-3120)
Cr Cash or Int Py 4,000 (100K bond @ stated rate 8% / 2)
Second Int Pymt
Dr Int Exp 3093.60 (new carrying amt = 104K - 880 = 130,210 *6% / 2)
Dr Premium on Bond Py 906.40 (4K - 3,093.60)
Cr Cash 4,000 (100K bond @ stated rate 8% / 2)
NOTICE: that the int exp decreases each period as the amortization increases. This is so with all bond premiums
What is the difference between serial bonds and term bonds?
MATURITY SCHEDULE:
Serial bonds: issued w/ scheduled maturities at various dates
Term bonds: issued w/ a single fixed maturity date
What is the difference between a secured vs debenture bond?
SECURITY TYPE
secured bond: backed by specific assets or collateral
debenture bonds: unsecured bonds not backed by collateral (can overlap with serial or term bonds)
What is the difference between callable and convertible bonds?
FEATURES
callable bonds: can be redeemed by the issuer b4 maturity
convertible bonds: can be converted into a predetermined # of CS
What is a zero-coupon bond?
sold at a discount and pay no periodic int, only face value at maturity
How do you determine the mkt price of a bond?
= PV of its principal amt + PV of all future int pymt, at the mkt (effective) int rate
What are the consequences of a bond issued BETWEEN interest pymt dates?
the issuer will receive not only the issuance price (eg 97% of par) BUT ALSO accrued int for the period between the int pymt and issuance date
eg, par $1M bond at 97 issuance = $970,000 for prin
+ semiannual pymt @ 10% on 1/1 and 7/1 = 50k each int due date
bond issued on 4/1, which is half way between 1/1 and 7/1, means $25K of accrued int will be added to the prin
SO total amt that issuer will receive for the bond is 970K + 25K = 995K
How are bond liabilities presented on the FS?
at carrying value = face +/- premium/disc +/- issuance costs
not to be confused with JE, where bond liab is listed at face value alone
How are bond issuance costs reported?
they reduce the cash rec’d b/c they are fees pd out (underwriting, legal, etc)
On the BS, these costs are netted against the premium or disc
eg, $500k bonds at 105 with 15K issuance costs
is 500K * 1.05 = $525K cash MINUS 15K = 510K cash
Dr Cash 510K
Cr Prem 10K
Cr Bond Liab 500K
How do you determine if a bond interest pymt is an ordinary annuity or an annuity due?
bonds always pay int at the end of the period, never at the beg
so unless the question explicitly says int is pd at the start of the period, assume an ordinary annuity
annuity due wording w/ such as “int pd at issuance” or “pymt at the beg of each period”, but very rare!
What happens to the interest expense on a discounted bond year after year?
The int exp increases each year b/c the amortization of the carrying value of the disc bond gets closer and closer to the face value every year
int exp = mkt rate @ time of issuance * carrying value (Bond py - disc @ time of pymt)
How do interest expense and carrying value behave for discount, premium, and par bonds under the effective interest method?
📉 Discount Bonds
- Interest exp = market rate × carrying value
- Carrying value increases over time
- Interest exp increases each period
- Discount is amortized → moves toward face value
📈 Premium Bonds
- Interest exp = market rate × carrying value
- Carrying value decreases over time
- Interest exp decreases each period
- Premium is amortized → moves toward face value
⚖️ Bonds Issued at Par
- Market rate = coupon rate
- No discount or premium
- No amortization
- Interest exp = cash interest payment
- Carrying value stays at face value
🧠 Quick Pattern
- Discount → ↑ CV, ↑ Int Exp
- Premium → ↓ CV, ↓ Int Exp
- Par → no change
If the bond is dated 10/1/Y1 but not issued 3 months later, how does that impact the recording of the bond payable?
Bond Date 10/1/Y1: this is when interest starts accruing.
the bond legally “exists” from this date for interest calc purposes
Issue Date 1/1/Y2: this is when the bond is actually sold and cash is rec’d
Accrued Int: the BUYER pays the issuer accrued int for those 3 mo @ issurance
b/c @ the next int pymt date, the issuer will pay the buyer the full int for the entire period, inclu the time b4 the buyer actually owned the bond
Bonds Payable (Net of disc or premium): record at ISSUE PRICE w/o incl accrued int.
Accrued int is a separate liab (int pay) or cash rec’d but not part of bonds py
so the issuer add’l cash at issuance to compensate for the int, but the bonds payable amt stays the same
record the extra cash as a accrued int, that will be washed out when the int pymt is made on the planned schedule
When is bond liab released aka extinguished aka defeasing debt?
- pd off at maturity at par
- pd off prior to maturity and a g/l is booked
- legal release of a debtor by law
≠ going into a trust
How is a gain calc’d for a debt restructuring?
eg, BV of debt = $150K exchanged for land w/ BV $75, FV $100
BV of Debt $150
minus FV of asset exchanged (100K)
= Gain on restructuring $50K
FV of asset exchanged $100K
minus BV of asset exchanged ($75)
= Gain on disposal/exchange $25K
- diff between BV and FV of asset = g/l
record two different JE for this transaction
How do you calc and report the g/l on early bond redemption, including the impact of unamortized issuance costs?
- when a bond is redeemed b4 maturity, the com must recognize a g/l on extinguishment
- g/l is calc as the differ between amt pd to redeem the bond and BV of bond at redemption
- BV incl face value adjusted from any unamortized disc or prem and unamortized bond issuance costs
- unamortized bond issuance costs reduce the BV, so if not fully amortized, they increase the loss on redemption
- g/l recognized on the I/S
- bond payable acct is dr @ par value, not the premium price pd
How do you report the g/l on early bond redemption, including the impact of unamortized issuance costs?
eg, face value of bond: $1M, unamortized disc = x (eg 42,500), unamortized bond issuance costs: y (eg 17,500), redemption price (premium): 1,020,000
1) Calc BV of bond at redemptions: face value - unamortized disc - unamortized issuance costs
is $1M - 42500 - 17,500 = 940,000
2) Calc loss on redemption: loss = redemption price - BV
is 1,020,000 - 940K = 80K
Dr Bond Payable 1,000,000
Dr Loss on Bond Redemption 80,000
Cr Disc on Bond Py 42,500
Cr Bond Issuance Costs 17,500
Cr Cash 1,020,000
How are bond issuance costs accounted for when a bond is extinguished?
Bond issuance costs:
- Record as an asset (deferred cost)
Dr Bond Issuance Costs (asset)
• Cr Cash
Amortize over life of bond
Dr Interest Expense
• Cr Bond Issuance Costs
When bond is extinguished:
- Write off any unamortized amount
- Incl in g/l on extinguishment
• ↑ loss (or ↓ gain)
Dr Loss on Extinguishment
• Cr Bond Issuance Costs
👉 “If it hasn’t been expensed yet, expense it NOW.”
Eg
• Total cost = $25,000
• Amortized = $7,500
• Unamortized = $17,500
👉 When bond is retired:
- Write off $17,500
- Add to loss on extinguishment
What is the significance of bond retirements being “unusual in nature” and “infrequent in occurrence”?
an item that is either unusual or infrequent or both are reported separately on the I/S w/in continuining operations
