Download Bonds Payable

Chapter 21
Corporate Bonds
1
College Accounting
10th Edition
McQuaig
McQuaig
Bille
Bille
Nobles
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
21–1
© 2011 Cengage Learning
Accounting Language
 A bond is a long-term obligation that provides
capital.
 For all practical purposes, a bond is a longterm promissory note.
 Bonds are recorded as Bonds Payable on
the balance sheet of a corporation in the
Long-Term Liabilities section.
 A bond issue refers to the total number of
bonds that a corporation issues at the same
time.
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Accounting Language
 Bonds are issued in denominations of $1,000
or $5,000 each, with $1,000 being more
common.
 All bond payables have a face value, or the
value that the corporation will pay at maturity.
 The end of the life of a bond is called the
maturity date and is the day the corporation
agrees to pay the bondholders.
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Bonds Classified as to Time of Payment
 All term bonds of a particular issue have the
same term, or time period to maturity.
 Serial bonds of a particular issue have a
series of maturity dates.
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Bonds Classified as to Security
 When bonds are secured bonds, they are
covered or collateralized by mortgages on
real estate or by titles to personal property.
 Unsecured bonds, also called debenture
bonds, are backed only by the corporation’s
credit standing, or good name.
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Advantages of Issuing Bonds
1. The bond-issuing corporation has the prospect
of earning a greater return on the money it
raises than it has to pay out in interest. This is
known as leverage.
2. Interest payments are tax-deductible
expenses.
3. Bondholders cannot vote; therefore, the
existing common stockholders retain control of
the company’s affairs.
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Disadvantages of Issuing Bonds
1. Bondholders are creditors of the corporation,
so interest payments must be made to
bondholders each year.
2. The corporation must eventually pay back
the principal of the bonds it issues, but does
not have to repay the money it receives from
issuing stock.
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Financing Alternatives
Midwest Development Corp., which has 160,000 shares
of $50-par common stock outstanding ($8,000,000),
wishes to raise an additional $4,000,000 for expansion.
Midwest Development Corp. is considering three
alternatives for raising the money.
Plan 1
Issue an additional $4,000,000 of common
stock, thereby increasing the total stock
outstanding from 160,000 to 240,000 shares.
Plan 2
Issue $4,000,000 of 8 percent cumulative
preferred stock.
Plan 3 Issue $4,000,000 of 7 percent bonds.
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Financing Alternatives
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Accounting for the
Issuance of Bonds
On January 1, Sean Construction Corporation issues
$500,000 of 6 percent, 5-year bonds at face value, with
interest payable semiannually, on June 30 and
December 31.
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Accounting for the
Issuance of Bonds
The interest payment is calculated as:
Face Value x Interest Rate x Time Period
The interest payment for the Sean Construction
Corporation would be $15,000 ($500,000 x 0.06 x 6/12).
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Bonds Sold at a Premium
 If a corporation offers a rate of interest that is higher than
the market rate for similar securities, investors may be
willing to pay a premium for the bonds.
 On January 1, Sean Construction Corporation issues
$750,000 of 9 percent, 10-year bonds at 103, with
interest payable semiannually, on June 30 and
December 31.
 The term “103” refers to the price of the bonds, it is a
percentage of the face value.
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Bonds Sold at a Premium
Selling the bonds at 103 provides $772,500 ($750,000 x
1.03) in cash.
Premium on Bond Payable represents the amount
received over and above the face value of the bonds.
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Bonds Sold at a Premium
Premium on Bonds Payable is listed right below the bond
account in the Long-Term Liabilities section of the balance
sheet.
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Bonds Sold at a Premium
The corporation will write off or amortize Premium on
Bonds Payable over the remaining life of the bond issue.
Interest of $33,750 ($750,000 x 0.09 x 6/12) is paid on
June 30.
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Bonds Sold at a Premium
The same entry is made again on December 31 to record
the second semiannual interest payment.
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Adjusting Entry for Bonds
Sold at a Premium
 Amortization represents the write-off of the premium
account and is calculated as:
Premium on Bonds Payable ÷ Bond Life
 The amortization each year for Sean Construction
Corporation would be $2,250 ($22,500 ÷ 10 years).
 The entry in Slide 29 appears as an adjusting entry at
the end of the fiscal period.
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Adjusting Entry for Bonds
Sold at a Premium
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Adjusting Entry for Bonds
Sold at a Premium
The balance in Interest Expense of $65,250 is the annual
interest expense on the books.
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Bonds Sold at a Premium with Interest
Payment Dates That Do Not Coincide
with the End of the Fiscal Year
 On March 1, George’s Electronics issues $6,000,000
worth of 20-year, 9 percent bonds, at 104, dated March
1, with interest payable semiannually on September 1
and March 1.
 The corporation’s fiscal year ends on December 31.
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Bonds Sold at a Premium with Interest
Payment Dates That Do Not Coincide
with the End of the Fiscal Year
The entry for March 1 of the first year, in general journal
form, is shown below.
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The remaining entries for the first year:
Bonds Sold at a Premium . . .
 The amortization of the premium on December 31 is
for only part of a year.
 The next year, amortization will be for a full year.
Bonds Sold at a Premium . . .
 Because the adjusting entry for accrued interest
opened a new balance sheet account, Interest
Payable, George’s Electronics’ accountant should
make a reversing entry.
 The reversing entry enables the accountant to follow
the regular routine for the payment of six months’
interest on March 1.
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The entries for the rest of the second year:
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The relevant T accounts from the previous year:
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Bonds Sold at a Discount
 A corporation can also issue bonds that will pay a rate of
interest that is less than the prevailing market rate of
interest for comparable bonds.
 If this happens, the corporation is said to sell its bonds at
a discount.
 On January 1, Stewart, Inc., issues 6 percent , 20-year
bonds with a face value of $700,000 at 96, with interest
to be paid semiannually on June 30 and December 31.
Bonds Sold at a Discount
Discount on Bonds Payable is a contra-liability
account; it is listed on a classified balance sheet as a
deduction from Bonds Payable.
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Bonds Sold at a Discount
The journal entries for the payment of interest semiannually
on June 30 and December 31:
Adjusting Entry for Bonds
Sold at a Discount
 The amortization of Discount on Bonds Payable is
calculated as:
Discount on Bonds Payable ÷ Bond Life
 The adjusting entry to amortize one year of the $28,000
discount on the 20-year bonds issued by Stewart, Inc.:
Adjusting Entry for Bonds
Sold at a Discount
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Adjusting Entry for Bonds
Sold at a Discount
The balance in Interest Expense of $43,400 is the annual
interest expense on the books.
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Bond Sinking Fund
 To provide greater security for bondholders, the bond
agreement may specify that the issuing corporation make
annual deposits of cash into a special fund—called a
sinking fund—to be used to pay off the bond issue when
it comes due.
 The sinking fund may be controlled by either the
corporation or a trustee—usually a bank.
 Both Sinking Fund Cash and Sinking Fund
Investments are classified as investment accounts.
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Bond Sinking Fund
 Flores Development issues $800,000 worth of 10-year
bonds dated January 1, with the provision that at the end
of each of the 10 years, it will make an equal deposit into
a sinking fund.
 The company will manage it owns sinking fund; expecting
to earn 6 percent each year.
 An annual deposit of $60,693 will accumulate to
approximately $800,000 in 10 years, given the 6 percent
annual interest rate.
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Bond Sinking Fund
• Annual deposit of cash in bond sinking fund
• Purchase of investments
Bond Sinking Fund
• Sale of investments
• Payment of bonds
Bond Sinking Fund
• Receipt of income from investments
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Redemption of Bonds
 To protect itself against a decline in market interest
rates, a corporation may issue callable bonds.
 Callable bonds give the corporation the right—as
stipulated in the bond indenture, or agreement—too
redeem or buy back the bonds at a specified figure—
the call price—that is ordinarily higher than the face
value.
 When a corporation redeems its bonds at a price that
is less than their book value, it realizes a gain.
 If a corporation redeems its bonds at a price that is
more than their book value, it incurs a loss.
 The book value is the sum of Bonds Payable and
Premium on Bonds Payable (or Bonds Payable less
Discount on Bonds Payable).
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Redemption of Bonds
Seneri, Inc., has $500,000 worth of callable bonds
outstanding on December 31, with a call price of 105;
there is an unamortized discount of $2,000. Interest is
paid on December 31 and exercises it options on the
same date.
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Redemption of Bonds
 Even if a corporation’s bonds are not callable, the firm
can buy back the bonds—all of them, or as many as it
can find, on the open market.
 Vince Fabrics has $1,000,000 worth of 7 percent bonds
outstanding, on which there is an unamortized premium
of $30,000. On July 15, Vince Fabrics buys $100,000 of
bonds (one-fourth of the original issue) in the open
market at 97, plus15 days’ accrued interest.
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Redemption of Bonds
Gain on Redemption of Bonds is listed on the
income statement under the Other Income heading.
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