Cpa Review- Far 5-3 (Long-Term Liabilities And Bonds Payable) (2)

Front 1

Bonds Payable

Back 1

-Should be recorded at face value and adjusted to the PV of their future cash outflows by either subtracting unamortized discounts or adding unamortized premiums.
-Recorded at the true PV at the date of issuance based on the market (effective) interest rate at that date.
-Usually in denominations of $1,000.
-Price is always quoted in 100's (% of par value)
-Indenture is a contract for purchase of bond.

Hint 1

-Coupon Rate = Stated Interest Rate on the bond.
-Bond Interest (check amount) = Coupon Rate x Face.
-Generally pay interest semi-annually in the U.S. and annually in other countries.
-Principal payoff is always the full face amount.
-Premium/discount is the result of buyer and seller "adjusting" the coupon rate to the prevailing market rate of interest.

Front 2

Bond Selling Price

Back 2

-Price is computed as the sum of the PV of future principal payment + the PV of the future periodic interest payments.
-Both CF's are discounted at the prevailing market rate of interest.

Hint 2

-This recorded price is the value of the bond at its current cash equivalent.

Front 3

Stated Interest Rate

Back 3

-Typically printed on the bond and included in the bond indenture before its brought to market.
-Will not change regardless of market rate at date of issuance.
-Although interest is typically paid semi-annually, it will accrue monthly.

Hint 3

-Amount of cash received at regular interest payment intervals over the life of the bond will always be at the stated rate applied to the face amount of the bond.
-If this rate ≠ market rate there is a premium or discount.

Front 4

Effective (Market) Interest Rate

Back 4

-Because amount of cash to be received in the future is fixed at the time bond is sold, market will automatically adjust the issue price of the bond so that the purchaser receives the market rate of interest for comparable risk bonds (i.e., the effective interest rate).

Hint 4

-(or the Yield) is the coupon rate adjusted for the premium or discount.

Front 5

Discounts

Back 5

-Stated Rate < Market Rate. Bond will sell for less than face value. Difference between face value and sales price of the bond is the automatic adjustment to the interest rate.
1. Unamortized Discount: on bonds payable, is a contra account to bonds payable. Presented on the B/S as a direct reduction from the face (par) value of the bonds to arrive at the bond's carrying value at any particular point in time.

Hint 5

2. Amortization of the Discount (General): bond discount represents additional interest to be paid to investors at the bond maturity and is amortized over the life of the bond. Amortized amounts increase interest expense each period. Amortization of the discount is added to the amount of cash paid at the stated rate to obtain GAAP interest expense.

Front 6

Premiums

Back 6

-Stated Rate > Market Rate. Bonds will sell than more than face value and the difference between face value and the sales price of the bond is the automatic adjustment to the interest rate.
1. Unamortized Premium: on bonds payable, is presented on the B/S as a direct addition to the face (par) value of the bonds to arrive at the bond's carrying value at any particular point in time.

Hint 6

2. Amortization of the Premium (General): bond premium represents interest paid in advance to the issuer by bondholders who then receive a return of this premium in the form of larger periodic interest payments (at the stated rate). Premium is amortized over the life of the bond w/ amortized amounts decreasing interest expense each period. Therefore, the amortization of the premium is subtracted from the amount of cash paid at the stated rate to obtain GAAP interest expense.

Front 7

Carrying Value

Back 7

-As bonds approach maturity, their carrying values approach face value so that the carrying value equals face value at maturity.
-Equals face value plus the balance of unamortized premium or minus the balance of unamortized discount.

Hint 7

-Carrying value of a bond with a discount increases to maturity value as the discount is amortized.
-Carrying value of a bond with a premium decreases to maturity value as the premium is amortized.

Front 8

Bond Issue Costs

Back 8

-Transaction costs of the bond issue. Should be recorded as a deferred charge (asset) and amortized from the date of issuance of the bonds into expense (typically interest or bond issue expense) using the straight-line method.

Hint 8

-Typically paid directly by the broker and are repaid to the broker by the company through the proceeds of the bond issue which means that the issuing company receives bond proceeds net of the bond issue costs.

Front 9

IFRS Bond Issue Costs

Back 9

-Under IFRS, bond issue costs aren't recorded as a separate asset.

Hint 9

-They are deducted from the carrying value of the liability and amortized using the effective interest method.

Front 10

Amortization Period

Back 10

-Under GAAP, bond premium/discount is amortized over the time period that the bonds are outstanding (from date sold).

Hint 10

-Under IFRS, amortization is done over the expected life of the bond, not the contractual life.

Front 11

Straight-Line Method

Back 11

-Divide the unamortized discount or premium by the number of time periods the bonds are outstanding and amortize the same amount of discount or premium each period.
-Results in constant dollar amount of interest each period.
-Not GAAP but allowed if results aren't materially different from the effective interest method.

Hint 11

-(Premium or Discount) ÷ (# of periods bond is outstanding) = Periodic Amortization
-Interest Expense = (Face Value x Stated Interest Rate) - Premium amortization or + Discount amortization
-Straight-Line method not permitted under IFRS

Front 12

Effective Interest Method

Back 12

-Required by GAAP & IFRS.
-Interest Expense = Carrying value at BEGINNING of period x Effective Interest Rate
-Amortization of Discount = Interest Expense - Cash interest paid at stated rate

Hint 12

-Amortization of Premium = Cash interest paid at stated rate - Interest Expense
-This method results in a constant rate of interest each period.

Front 13

Bonds Issued Between Interest Dates

Back 13

-Requires additional entries for accrued interest at the time of sale.
-Amount of interest that has accrued since the last interest payment is added to the price of the bond.

Hint 13

-The purchaser pays such interest and is reimbursed at the next payment date upon receipt of a full period's interest.

Front 14

Year-End Bond Interest Accrual

Back 14

-If the date a scheduled interest payment and the issuer's year-end do not agree, it is necessary to accrue interest by an adjusting entry on the issuer's book at year-end.

Hint 14

-Accrual must take into account a pro-rated share of discount or premium amortization.

Front 15

Bond Sinking Fund

Back 15

-A trustee fund (restricted cash) that the company contributes money to each year so that at maturity, there is a sum available to repay the entire liability.
-Generally a non-current (restricted) asset on F/S's of the issuer. Current asset only to the extent that it offsets a current liability.
-Earns interest or dividends over time. Amount accumulated from regular deposits with the trustee serve as collateral for the issued bonds.

Hint 15

-Merely an appropriation of R/E's to indicate to shareholders that certain R/E's are being accumulated for bond sinking purposes.
-Amount of current maturities of long-term debt doesn't include the annual sinking fun requirement (outlined in bond indenture) but amount would be included as a footnote.
-Determination of Periodic Sinking Fund Payments: FV of an annuity of $1 at an assumed rate should be used.

Front 16

Serial Bonds

Back 16

-Alternative to sinking funds.
-Have principals that mature in installments, allow issuer to match maturity dates w/ the organizations CF requirements.
-PV of each maturity in the series should be separately calculated as in the case of a term bond.
1. Since short and long-term interest rates differ, there could also be a different premium or discount relating to each maturity.
2. One account, Unamortized Bond Discount or Bond Premium is used to accumulate all the discounts or premiums for each maturity.

Hint 16

3. The PV of each periodic interest payments for each maturity is calculated separately, based on these different yield rates, just as w/ separate term bonds.
4. When underwriters bid on an entire serial bond issue at one average interest rate, an average yield can be used for all maturities in the series to calculate interest expense.
5. Amortization Methods: (1) Effective Interest Method, (2) Bonds Outstanding Method- variation of the SL method, uses the % of decrease in outstanding debt each maturity period as the basis for calculating the related amount of premium or discount on the bonds (not GAAP).

Front 17

Convertible Bonds

Back 17

= Nondetachable Warrants
-Often issued at more than face value b/c of the conversion feature.
-Under GAAP, issuance price is allocated to the bonds with no recognition of the conversion feature b/c it is to difficult to assign a specific value to it.
-Conversion of bonds can be recorded under the Book Value (GAAP) or Market Value Methods (not GAAP).

Hint 17

-Under IFRS, both a liability (bond) and an equity component (conversion feature) should be recognized when issued.
-Bond Liability is valued at FV, with the difference between the actual proceeds received and the FV of the bond liability recorded as the equity component.
-Similar to accounting for bonds w/ detachable warrants.

Front 18

Book Value Method

Back 18

-NO GAIN OR LOSS recognized.
-At conversion, the bonds payable and related premium or discount are written off and common stock is credited (at par). APIC is credited for the excess of the bond's carrying value over the stock's par value less any conversion costs.

Hint 18

-No gain or loss is recognized b/c the BV method views the conversion as the completion os a prior transaction (issuance of convertible debt), rather than viewing it as culmination of the earning process.

Front 19

BV Upon Conversion

Back 19

-Issuer must:
1. Pay accrued interest up to the conversion date.
2. Amortize the bond discount or premium up to the conversion date.

Hint 19

3. Amortize the bond issue costs up to the conversion date.
4. Record any difference as APIC.

Front 20

Market Value Method

Back 20

-View the conversion as culmination of the earnings process, thereby resulting in a recognized gain or loss.
-At conversion, the bonds payable and related premium are written off, and common stock is credited (at par).
-Credit to APIC is the excess of the market price of the stock over par value.

Hint 20

-Difference between the market value of the stock and the book value of the bonds is a recognized gain or loss on redemption.
-This method has an I/S impact but is not GAAP.

Front 21

Convertible Bonds Premium

Back 21

-Often issued at more than face value b/c of the value of the stock.
-Since conversion feature can't be assigned a value, difference between the proceeds and FV of the bonds is recorded as a premium on bonds payable.

Hint 21

-When the conversion feature is exercised, any unamortized premium attributable to that portion of the converted bonds must be written off.

Front 22

Bonds W/ Detachable Stock Purchase Warrants

Back 22

-Warrants are option contracts that are issued with, and detachable from, bonds. They give the bondholder the right to buy stock at a fixed price within a specific time period.
-They are traded separately and considered to be a separate financial instrument b/c they are detachable.
-ACCOUNT FOR SEPARATELY: conversion feature should be accounted for separately with a value assigned to it. Value assigned is its relative FV at the time of issue. This amount is credited to APIC- warrants.

Hint 22

Allocation Steps:
1. Separate the warrants from the debt at the date of issuance of the bonds.
2. Allocate the amount received upon issuance separately to bonds and detachable warrants based on their relative FV at issuance date (if only one items FV is known, allocate the remainder of proceeds to unknown FV item).
3. Amount that is allocated to warrants is credited to "APIC- warrants" in the S/E section.
4. Difference between the amount allocated to the bonds and the face value (par) should be debited or credited to "discount or premium on bonds payable."

Front 23

Callable & Refundable Bonds

Back 23

-Callable bonds can be retired after a certain date at a stated price.

Hint 23

-Refundable Bonds allow an existing issue to be retired and replaced with a new issue at a lower interest rate.

Front 24

Extinguishment of Debt

Back 24

-Liability cannot be derecognized in the F/S's until it has been extinguished. Considered extinguished when:
1. Debtor Pays: (the creditor) at is relieved of the obligation for the liability. If at bond maturity, carrying value = face value so no gain/loss. If before maturity, a gain or loss is generally recorded.

Hint 24

2. Debtor Legally Released: either judicially or by the creditor.

Front 25

Gain/Loss on Bond Extinguishment

Back 25

(Before Maturity)
-Adjust and account for the following items in the F/S's:
1. Bond issue costs reported as an asset under GAAP,

Hint 25

2. Any related unamortized discount or premium, and
3. The difference between the bond's face value and the reacquisition proceeds.

Front 26

Gain/Loss Calculation

Back 26

= *Reacquisition Price - **Net Carrying Amount
*Usually shown as a % of bond's face value.
**= face value of bond ± unamortized premium (discount) - unamortized bond issue costs.

Hint 26

-Under GAAP, the gain or loss on bond extinguishments will be treated as an extraordinary item, net of the related tax effect, if it is material in aggregate, unusual in nature, and has occurred infrequently.