LONG-TERM LIABILITIES

par value

Bond is a written promise to pay an amount identified as the _____ (or face value) of the bond along with Interest (usually semiannually) at a stated annual rate

Advantages of Bonds:

stock holder

Bonds do not affect _________  control as they have no ownership control

Advantages of Bonds:

Tax deductable

Interest on bonds is __________  unlike dividends to stockholders

Disadvantages of Bonds:

Increase

Bonds can _______ return on equity by earning a higher rate than they are paying out

Disadvantages of Bonds:

Interest, maturity

Bonds require periodic _____ payments and payment of the par value at _______

Bond Trading

1.  Are usually in denominations of 1,000 or 5,000

2.  Have a market value expressed as a of their par (face) value (103 ½ or 95)

3.   Bond Indenture – legal document between bondholders and issuer

Issuing bonds at par

1.              Record the sale

2.              Interest expense = Face  x  Interest Rate x  Interest Period

3.              Maturity date

Interest expense =

Face  x  Interest Rate x  Interest Period

Contract rate

annual interest rate paid by the issuer; sets the amount of interest the issuer pays in cash

Market rate

annual rate borrowers are willing to pay and lenders are willing to accept

= , par

Contract rate ___ market rate, then bond sells at ___

>, premium

Contract rate _____ market rate, then bond sells at a _____

< , discount

Contract rate____ market rate, then bond sells at a _____

present value

Bond price equals the _________ of the bond’s future cash flows discounted at the market rate

Computation is twofold

a.              Present value of the maturity payment (a single sum) table B.1

b.              Present value of the periodic interest payment (an annuity) Table B.3

contra – Liability

Discount on Bonds Payable is a _________ account (= par value minus issue price)

Amortization of Bond Discount

a.               Total bond interest expense is the sum of the interest payments and bond discount

b.              Must be amortized over the life of the bond

c.               At maturity, the book value will equal the face value

Straight line

(simpler) allocates an equal portion of the total discount to bond interest expense in each of the six-month interest periods

Effective Interest Method

(Appendix 14B) (GAAP preferred method) allocates bond interest expense over the life of the bond in a way that yields a constant rate of interest

Issuing Bonds at a Premium (sells for more than the face amount)

Premium on Bonds Payable is an adjunct liability account (= issue price minus par value)

Amortization of Bond Premium

a.               Total bond interest expense is the interest payment minus the bond premium

b.              Must be amortized over the life of the bond

c.               At maturity, the book value will equal the face value

Straight Line

(simpler) allocates an equal portion of the total premium to bond interest expense in each of the six-month interest periods

Effective Interest Method

(Appendix 14B) (GAAP preferred method) allocates bond interest expense over the life of the bond in a way that yields a constant rate of interest

Bond Retirements

A.             At maturity, carrying value will equal the par value

B.              Before maturity, the difference between the purchase price and the bonds carrying value is a gain or loss on retirement

C.              Converted to stock, the carrying value is transferred to contributed capital with no gain or loss

Debt-to-Equity Ratio

1. Used to determine the risk of a company’s financing structure

2. Total Liabilities / Total Equity

Secured Bonds

have specific assets pledged as collateral

Unsecured Bonds

backed by the issuer’s general credit standing

Term Bonds

scheduled for payment at a single specified date

Serial Bonds

mature at more than one date

Sinking Fund Bonds

amounts set aside for repayment of the bonds

Registered Bonds

issued in the names and addresses of the holders

Bearer Bonds

not registered, payable to whoever holds them

Coupon Bonds

interest coupon is detached & presented for payment

Convertible Bonds

can be exchanged for common stock

Callable Bonds

issuer can retire them early at a stated dollar amount

Municipal Bonds

issued by state or local governments – tax-exempt 

Installment Notes

1.              Record initially as a single payment note

2.              Payments include interest expense accruing to date of payment plus principal

Mortgage Notes

1.              Pledge title to specific assets as security for the note

2.              Lender has the right to foreclose if the borrower fails to pay