W12 - Acct

Bond Accounting Overview

Bond Premium and Discount

• When a bond is issued above its face value, it is said to be issued at a premium.

• When a bond is issued below its face value, it is said to be issued at a discount.

• The premium or discount affects the interest expense recognized over the life of the bond.

Premium Calculation

• Example:

  • Face value of bond: $100,000$

  • Issued price (premium): $114,877$

  • The difference is $14,877$ which is amortized over the bond's life, reducing interest expense.

• Market rate of interest: 6 ext{%}

  • Calculated as:
    $ext{Interest Expense} = ext{Market Rate} imes ext{Carrying Value} / 2$

Amortization Example

• Annual amortization example calculation:

  • Year 1 interest payment: $4,000$

  • At the end of the period carrying value: $114,000$

  • Market rate calculation: rac{114,000 imes 6 ext{%}}{2}

  • Result: Decreasing interest expense over time as carrying value declines and premium amortized.

Time Value of Money

• The formula for present value of cash flows:

  • $PV = rac{1}{(1 + r)^n}$ where

  • $PV$ = Present Value

  • $r$ = Market interest rate

  • $n$ = Number of periods

• Importance of time value of money:

  • A dollar today is worth more than a dollar in the future due to inflation and opportunity for investment.

Annuity Valuation

• A bond can be viewed as an annuity stream (coupon payments) plus a lump sum (face value at maturity).

• Present value of future cash flows determines the bond's valuation:

  • $Value = ext{(Annuity value)} + ext{(Present value of face value)}$

Example of Discounting Cash Flows

• If market rate increases (e.g., 10 ext{%}): bond value decreases.

• Bond is valued based on future cash flows:

  • $ext{Coupon Payment} = 4,000$ (semi-annually).

  • At maturity, repay $100,000$.

Bonds Issued at Par

• Occurs when coupon rate equals market rate; issued at face value.

• This is a conceptual exercise related to timing of issuance and changing interest rates over time.

Effective Interest Rate Method

• As bonds are amortized, expense recognized is based on effective interest rate not just stated (coupon) rate.

• As carrying value of the bond changes, so does the interest expense.

Journal Entries for Bond Accounting

• Typical entries:

  • Interest Payment:

  • Debit: Interest Expense

  • Credit: Cash

  • Credit: Bonds Payable (when premium amortization applies)

• At maturity, the entry to repay the bond:

  • Debit: Bonds Payable

  • Credit: Cash

Common and Preferred Shares

• Differences between types of shares and their characteristics (e.g., voting rights, dividend preference).

• Legal Capital: Funds raised by the issuance of stocks cannot be distributed as dividends.

Share Issuance Example

• Issue of 10,000 shares at $10$ per share:

  • $ext{Cash Debit} = 100,000$

  • $ext{Common Shares Credit} = 100,000$

Repurchase of Shares

• Companies may repurchase shares to consolidate ownership or enhance shareholder value.

• Gain or Loss on repurchase affects equity differently depending on whether the repurchase price is above or below average cost.

• If repurchased at a premium (higher than average cost), the loss is deducted from retained earnings.

Dividends

• Three key dates related to dividends:

  • Declaration Date: Boards publicly announce dividend payment.

  • Record Date: Determines entitlement to the dividend.

  • Payment Date: Actual cash dividend distribution occurs.

Declaration Cost Accounting

• Entry on declaration date:

  • Debit: Retained Earnings

  • Credit: Dividends Payable

• Entry on payment date:

  • Debit: Dividends Payable

  • Credit: Cash

Stock Dividends and Splits

• Stock dividends involve issuing additional shares to existing shareholders, diluting their share.

• Stock splits increase shares outstanding but do not change the overall value of the investment.

• Example of a stock split:

  • 2-for-1 split increases number of shares while halving price per share.

Impact on Corporate Structure and Taxes

• Corporations can be advantageous in terms of liability protection, potential tax benefits, and easier capital-raising strategies compared to sole proprietorships or partnerships.

• Important distinctions between private and public corporations, regarding liabilities and operation regulations.

Issuing Preferred Shares

• Preferred shares typically provide fixed dividend rates with preference in payment over common shares in case of liquidation.

• Holders generally do not have voting rights; however, some shares can be convertible.

Accounting for Preferred Shares

• Journal entries similar to common shares but focus on dividends expiring before common shareholders.

• Cumulative vs. non-cumulative dividends define payment obligations in periods of profit.