Bonds

Discount = (more interest)

• Effectively raises the interest over stated rate for both sides..
• Issuer: increases interest expense
• Investor: increase interest income
Premium = (less interest)
• Stated rate is > effective yield
Lender => record discounts and premiums and bond issue costs
Purchaser => record bond at amortized cost

Issuer JE’s upon issuing @ discount

Cash 490K [how much cash was collected]
Discount 10K
B/P 500K [face amount of bond]

Upon payoff of bond by issuer

B/P 500K
Cash 500K

Carrying Value of a Bond

Face Amount
(+) unamortized premium
(-) unamortized discount
Carrying value of bond on B/S

Interest Adjustments – Straight Line Amortization

• Actual interest paid out = (Face * Stated coupon rate)

Interest Expense xx
Discount Amortization xx [Discount / # of periods)
Accrued Interest Payable xx [Coupon rate * face]

Interest Adjustments – Effective Interest Method

• Only affects interest calculations (not initial recording of bond issuance)

Interest expense = (Effective yield * Carrying Value)

Discount Amortization (cr.) = Interest expense – Interest payable

Interest Expense xx [eff yield * Carrying value]

Accrued Interest Payable xx [Face * coupon rate]
Discount Amortization xx [PLUG]

Investor JE @ date of purchase

Facts: Buy $400K bonds for $369,200 to yield 10%. Coupon rate = 8%. 5-yr maturity, bonds pay
interest semiannually.

Investment in bond 369,200

Cash 369,200
*Note: Investor does not setup separate discount/premium account. Instead, record all bonds @ cost on
B/S.

JE for 1 6 months – Straight Line

st

Interest receivable 16,000 [400K * 8% coupon * 6/12 mths]

Investment in bonds 3,080 [30,800 premium / 10 periods]
Interest income 19,080

JE for 1 6 months – Effective Interest Method

st

Interest receivable 16,000 [same as SL, above]

Investment in bonds 2,460 [PLUG]
Interest income 18,460 [10%/2* 369,200]

Determining the Market Price of a Bond

• PV of $1 on principal
• Note: Don’t forget to use semi-annual rate * double periods if the problem states interest
is payable semiannualy
• PV factor @ effective rate * Face amount of Bond)
• PV of $1 (annuity) on the actual interest checks sent out
• PVA factor @ effective rate * (Coupon PMT)

Bond Issue Costs

• Include legal fees, accounting fees, underwriting commissions, registration, printing and
engraving, promotion costs, and other such costs incurred in preparing and selling a bond issue.
• Treatment: Deferred Charge (asset) and amortize over life of the bond, increasing interest
expense
• Amortize from sale date to maturity date (if issued after bond is dated)
• Does not affect reporting of the bond liability (equal to Face (+/-) disc or prem)

Bond Issue Costs (BIC) 50

Cash 950
Bond Payable @ par 1000

Term Bonds = Mature on a single date

Serial Bonds = Mature in installments

Bonds w/Detachable Stock Warrants

• Allocate proceeds to bonds/warrants based on relative FV of each (get a %)
• Multiply this % by Proceeds (cash received) to arrive at JE

Cash 240
DBP 1
B/P 200
APIC – warrants 41
Convertible Bonds
At issuance: The liability and contributed capital are inseparable (like a warrant is)

Cash xx
Debt liab xx

Book Value Approach: Conversion JE

• Use carrying value of bonds, do not recognize a gain/loss

Bond Payable 100

Unamort Prem 10
C/S – Par 50
APIC 60 [PLUG]

Market Value Method: Conversion JE

• Recognize gain/loss equal to difference between CV of bonds and FMV of shares upon
conversion

Bond Payable 100

Unamort prem 10
C/S – Par 50
APIC 40 [FMV – BV of stock]
Gain 20 [CV of bond – FMV of stock]