accounting - clutch ch. 11 - long term...

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ACCOUNTING - CLUTCH

CH. 11 - LONG TERM LIABILITIES

CONCEPT: INTRODUCTION TO BONDS AND BOND CHARACTERISTICS

● Bonds Payable are groups of debt securities issued to _____________________ lenders

□ Example: Company wants to raise $1,000,000. The company can sell 1,000 bonds worth $1,000 each.

□ The company will pay _______________ on the bonds annually or semi-annually.

□ The company repays the _________________ amount of the bonds (i.e. $1,000 per bond) on the maturity date.

Repayment Characteristics:

● Term Bonds – bonds with one maturity date; the principal is paid back in a __________________

● Serial Bonds – bonds with multiple maturity dates; the principal is paid back in _________________ Collateral Characteristics:

● Secured Bonds – bonds that are collateralized by certain assets (such as a mortgage) _______ risk

● Debenture Bonds – bonds that are backed only by the good faith of the borrower _______ risk Other Characteristics:

● Callable Bonds – bonds that can be repurchased by the issuer at the “call price” at any time before the maturity date

● Convertible Bonds – bonds that can converted into shares of __________________ in the company Interest Rate Characteristics:

● Stated Rate – the rate printed on the face of the bond; also called the coupon rate

□ This determines the amount of cash interest that will be paid (credit to Cash in each interest journal entry)

● Market Rate – the going interest rate for similar bonds on the open market; also called the effective rate

□ This determines the selling price of the bond and the amount of Interest Expense (debit to Interest Expense)

Bond Issuance Terminology:

● Bond prices are quoted at a percentage of their maturity value:

□ A $1,000 bond quoted at 100 is bought or sold for ___________, which is 100% of the face value

□ A $1,000 bond quoted at 103 is bought or sold for ___________, which is 103% of the face value

□ A $1,000 bond quoted at 92.375 is bought or sold for ___________, which is 92.375% of the face value

● Face Value – the principal amount of the bond

● Discount Price – a price ____________ face value; this occurs when the stated rate is ____________ the market rate

● Premium Price – a price ____________ face value; this occurs when the stated rate is ____________ the market rate

ACCOUNTING - CLUTCH


CONCEPT: FACE VALUE BONDS

● A bond is issued at face value when the stated interest rate is ________________ the market interest rate

□ The selling price of a bond is equal to the present value of the interest payments and principal payments

Stated Rate = Market Rate The price of the bond will be _______________ the face value

Stated Rate < Market Rate The price of the bond will be _______________ the face value

Stated Rate > Market Rate The price of the bond will be _______________ the face value

● Bonds are initially issued and the respective journal entry is made:

On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 9%. January 1, 2018 Journal Entry:

Assets

= Liabilities + Equity

● Interest is paid in cash on the interest payment dates. A journal entry is made for interest expense:

On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 9%. July 1, 2018 Journal Entry:

Assets


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● Interest is paid in cash on the interest payment dates. A journal entry is made for interest expense:

On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 9%. December 31, 2018 Journal Entry:

Assets


● On the maturity date, the company repays the principal and removes the bonds payable from the books:


Assets


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CONCEPT: DISCOUNT ON BONDS

● A bond is issued at a discount when the stated interest rate is ________________ the market interest rate






On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 10%. The bonds were issued at 94. January 1, 2018 Journal Entry:

Assets


● Interest is paid in cash. A journal entry is made for interest expense and discount amortization:

On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 10%. The bonds were issued at 94. July 1, 2018 Journal Entry:

Assets


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On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 10%. The bonds were issued at 94. December 31, 2018 Journal Entry:

Assets




Assets


PRACTICE: In 2014, ABC Company issued $100,000, 10%, bonds while the market interest rate was 12%. The bonds

mature in the current year. The amount of principal that ABC Company will repay in the current year is equal to:

a) $0

b) An amount greater than $0 but less than $100,000

c) $100,000

d) Some amount greater than $100,000

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CONCEPT: PREMIUM ON BONDS

● A bond is issued at a premium when the stated interest rate is ________________ the market interest rate







Assets


● Interest is paid in cash. A journal entry is made for interest expense and premium amortization:


Assets


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On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 8%. The bonds were issued at 108. December 31, 2018 Journal Entry:

Assets




Assets


PRACTICE: The carrying value (i.e. book value) of Bonds Payable is equal to:

a) Bonds Payable + Accrued Interest

b) Bonds Payable – Premium on Bonds Payable

c) Bonds Payable – Amortization of Premium on Bonds Payable

d) Bonds Payable – Discount on Bonds Payable

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CONCEPT: ZERO COUPON BONDS

● A zero coupon bond has no ___________ payments. The stated rate on these bonds is ____________.






On January 1, 2018, ABC Company issues $50,000 of zero coupon bonds maturing in five years. The market interest rate was equal to 8%. The bonds were issued at 85. January 1, 2018 Journal Entry:

Assets


● There is no cash interest. However, a journal entry is made for interest expense and discount amortization:

On January 1, 2018, ABC Company issues $50,000 of zero coupon bonds maturing in five years. The market interest rate was equal to 8%. The bonds were issued at 85. December 31, 2018 Journal Entry:

Assets


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On January 1, 2018, ABC Company issues $50,000 of zero coupon bonds maturing in five years. The market interest rate was equal to 8%. The bonds were issued at 85. January 1, 2023 Journal Entry:

Assets


PRACTICE: On January 1, ABC Company issues $1,000,000 of zero coupon bonds at 75. The bonds mature in five years.

Assuming that ABC uses the straight-line method for amortization of bond premiums and discounts, the journal entry at the

end of the first year would include:

a) A credit to Cash of $50,000

b) A credit to Interest Payable of $50,000

c) A credit to Discounts on Bonds Payable of $50,000

d) A credit to Bonds Payable of $50,000

e) None of the above

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CONCEPT: STRAIGHT LINE AMORTIZATION OF BOND PREMIUM OR DISCOUNT




● Premium Bonds are initially issued and the respective journal entry is made:


Assets


𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝐴𝑚𝑜𝑢𝑛𝑡 =𝑇𝑜𝑡𝑎𝑙 𝐵𝑜𝑛𝑑 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 𝑜𝑟 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑒𝑟𝑖𝑜𝑑𝑠



Assets


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● Discount Bonds are initially issued and the respective journal entry is made:


Assets


𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝐴𝑚𝑜𝑢𝑛𝑡 =𝑇𝑜𝑡𝑎𝑙 𝐵𝑜𝑛𝑑 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 𝑜𝑟 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡

𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑒𝑟𝑖𝑜𝑑𝑠



Assets


PRACTICE: Jayster Company issued bonds at a discount. The semi-annual journal entry for interest expense will include:

a) A debit to Discount on Bonds Payable

b) A debit to Premium on Bonds Payable

c) A credit to Discount on Bonds Payable

d) A credit to Premium on Bonds Payable

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CONCEPT: EFFECTIVE INTEREST AMORTIZATION OF BOND PREMIUM OR DISCOUNT




● The selling price of a bond is equal to the present value of the interest payments and principal payments:


Bond Carrying Value = Bonds Payable Account – Discount on Bonds Payable (or + Premium on Bonds Payable)

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝐵𝑜𝑛𝑑 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒 ∗ 𝑀𝑎𝑟𝑘𝑒𝑡 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒

𝐶𝑎𝑠ℎ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝐵𝑜𝑛𝑑𝑠 ∗ 𝑆𝑡𝑎𝑡𝑒𝑑 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒

𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑜𝑟 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 = |𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 − 𝐶𝑎𝑠ℎ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑎𝑦𝑚𝑒𝑛𝑡|

Interest Expense JE for Discount Bond

Interest Expense JE for Premium Bond

ACCOUNTING - CLUTCH


On January 1, 2018, ABC Company issues $100,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 10%.

Semi-annual Interest Date

Beginning Bond Carrying

Value

Interest Payment

(Credit to Cash)

Interest Expense

(Debit to Int. Exp)

Discount Amort.

(Credit to Discount on

BP)

Discount Account Balance

Ending Bond Carrying Value

1/1/2018

7/1/2018

1/1/2019

7/1/2019

1/1/2020

7/1/2020

1/1/2021

7/1/2021

1/1/2022

7/1/2022

1/1/2023


On January 1, 2018, ABC Company issues $100,000 of 9% bonds payable maturing in five years. Interest is payable semi-annually on January 1 and July 1. The market interest rate was equal to 10%. July 1, 2018 Journal Entry:

December 31, 2018 Journal Entry:

January 1, 2019 Journal Entry:

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CONCEPT: REDEEMING BONDS BEFORE MATURITY

● A company may decide to redeem (i.e. repurchase) their bonds before maturity:

□ No longer require the loan and desire to stop paying interest

□ Interest rates have fallen; could save money on interest by repurchasing old bonds and issuing new bonds

● The company will repurchase the bonds at a different price than the current __________________ of the bonds

□ The difference between the repurchase price and the carrying value will result in a _________ or _________

𝐺𝑎𝑖𝑛 𝑜𝑟 𝐿𝑜𝑠𝑠 𝑜𝑛 𝑅𝑒𝑡𝑖𝑟𝑒𝑚𝑒𝑛𝑡 = 𝑅𝑒𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐵𝑜𝑛𝑑𝑠

On January 1, 2012, RX Enterprises issued $100,000 of 7% bonds maturing in ten years when other bonds of similar risk were paying 8%. The bonds were issued at 94 and paid semi-annual interest on January 1 and July 1. During 2012, the market rate of interest dropped to 6%. On January 1, 2013, RX decided to repurchase the bonds when the market price was $106,000. Repurchase Price: Carrying Value of Bonds: January 1, 2013 Journal Entry:

On January 1, 2012, RX Enterprises issued $100,000 of 7% bonds maturing in ten years when other bonds of similar risk were paying 8%. The bonds were issued at 94 and paid semi-annual interest on January 1 and July 1. During 2012, the market rate of interest increased to 10%. On January 1, 2013, RX decided to repurchase the bonds when the market price was $88,000. Repurchase Price: Carrying Value of Bonds: January 1, 2013 Journal Entry:

ACCOUNTING - CLUTCH


accounting - clutch ch. 11 - long term...

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