Corporations and Bonds Payable

1
Corporations and Bonds Payable

• Chapter 21

2
Learning Objective 1

• Journalizing the recording of bondsas well as
• interest payments.

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Learning Unit 21-1

• Each bond certificate is usually issued in
  denominations of 1,000.
• The face value is the amount to be repaid at
  maturity date.
• The contract rate is the stated interest rate.
• A bond indenture is a written agreement.
• A trustee usually monitors bond activities.

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Learning Unit 21-1

• Bonds are stated at a percentage of face value.
• Bonds are 100 if the bond rate and market
  interest rate are equal.
• A bond discount occurs when the bond rate is
  lower than market rate.
• Bonds are sold at a premium when the bond rate is
  higher than market rate.

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Learning Unit 21-1

• What are some types of bonds?
• secured bonds
• debenture bonds
• registered bonds
• callable bonds
• convertible bonds

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Learning Unit 21-1

• Bond issuance requires interest to be paid.
• Interest expense reduces net income, thereby
  reducing income tax.
• Issuing bonds is borrowing while issuing shares
  of stock means less ownership for existing
  shareholders (unless they buy the new shares).

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Learning Unit 21-1

• Interest on bonds must be paid each year.
• Dividend payments are optional.
• Bonds are a long-term liability.
• Interest is computed on a semi-annual basis.

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Learning Unit 21-1
Face value Stated rate 6/12 Amount of
interest to be paid in cash each 6 months.
Face value Market rate at issuance date
6/12 Amount to be debited to interest
expense every 6 months (effective method)
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Learning Unit 21-1

• The above are equal if bonds were sold at 100.
• If bonds were not sold at 100, a bond discount
  or bond premium exists.
• A discount or premium is amortized at the
  interest payment date.

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Learning Objectives 2 and 3

• Amortizing bond discounts
• and bond premiums by the
• straight-line method and by
• the interest method.
• Journalizing year-end adjusting
• entries for bonds.

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Learning Unit 21-2
Straight-Line Method
The discount (or premium) is divided by
the number of interest periods for the bond
issue and provides the amount for amortization.
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Learning Unit 21-2

• Amortization of a discount increases interest
  expense.
• Amortization of a premium decreases interest
  expense.

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Learning Unit 21-2
Bonds with a face value of 200,000 are sold at
97. The contract rate of interest is 12 (20
periods). The market rate is 12.4.
Cash 194,000 Discount on Bonds Payable
6,000 Bonds Payable 200,000
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Learning Unit 21-2

• Discount amortization 6,000 20 300
• How much is the interest payable at the end of
  period one?
• 200,000 12 6/12 12,000
• How much is the interest expense?
• 300 (bond amortization) 12,000 (interest
  payable) 12,300

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Learning Unit 21-2
Bonds with a face value of 200,000 are sold at
102. The contract rate of interest is 12. The
market rate is 11.8.
Cash 204,000 Bonds Payable 200,000
Premium on Bonds Payable 4,000
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Learning Unit 21-2

• Cash payment is 12,000.
• 4,000/20 200
• Premium amortization is 200.
• Interest expense is 12,000 200 11,800
• What is the journal entry at the end of period
  one?

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Learning Unit 21-2
Interest Expense 11,800 Premium Bonds
Payable (amortization)
200 Cash 12,000
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Learning Unit 21-3
Interest Method
The interest method makes interest expense
a constant percentage of the bond carrying value.
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Learning Unit 21-3

• Face value Stated rate 6/12 Amount of
  interest to be paid in cash each 6 months
• Carrying value Market rate at issuance date
  6/12 Amount to be debited to Interest Expense
  every 6 months
• The above are equal if bonds were sold at 100.

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Learning Unit 21-3

• Assume that Yang Corporation is issuing 200,000
  of 12, ten-year bonds on April 1. Interest is
  to be paid on October 1 and April 1.
• The selling price of the bonds is 178,808.
• The market rate is 14 .

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Learning Unit 21-3

• What is the interest paid to bondholders at the
  end of period one?
• 200,000 12 6/12 12,000
• What is the interest expense?
• 178,808 14 6/12 12,517
• What is the discount amortization?
• 517

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Learning Unit 21-3
Interest Expense 12,517 Cash 12,00
0 Discount on Bonds Payable (amortization)
517
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Learning Unit 21-3

• Assume that on December 31, three months interest
  of 6,000 for the second period has accrued. What
  is the adjusting entry?

Interest Expense 6,276.50 Discount on Bonds
Payable 276.50 Bond interest
payable 6,000.00
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Learning Objective 4

• Journalizing entries related
• to retirement of bonds
• and to sinking funds.

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Learning Unit 21-4

• Bonds are a long-term liability.
• Liabilities are paid at maturity (or early).
• Amortization must be brought up to date and
  interest paid to bondholders.
• Maturity value (face value of bonds) is paid.
• Some issues require a sinking fund in which cash
  is set aside to repay the bonds at maturity date.

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Learning Unit 21-4

• Assume that on June 30, a corporation retired a
  500,000, 10 bond issue that had an unamortized
  premium of 19,000.
• The bonds were called at 105.
• What is the journal entry?

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Learning Unit 21-4
Bonds Payable 500,000 Premium on Bonds
Payable 19,000 Loss on Bond Retirement
6,000 Cash 525,000 Retirement of bond
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End of Chapter 21