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Study Smarter.....Study The Answers!

Bonds Payable and Other Long Term Liabilities

1) Key Things To Know 5) Medium Practice Test
2) Self Test 6) Hard Practice Test
3) Practice as You Learn 7) On Your Test
4) Easy Practice Test 8) Quick Study Sheet

 

 

Key Things to Know

 Bonds Payable–  borrow from investors who invest in the bond to earn a return of
                               interest income
 
     The bond is a contract with the investor that loaned the money. 
       Every bond is a contract which has the following:
 
            Maturity Value:                     Amount that must be repaid (usually in $1,000s)
            Maturity Date:                       Date the maturity value amount must be repaid
            Stated Interest Rate:            “Coupon” – amount paid as interest, periodically-
                                                          monthly, semi-annually or annually
 
       Market Yield/Effective interest rate:  The interest the company really incurs,
                                                                   and the investor really earns
 
 
Simplified Example:           $1,000 Maturity Value (MV) due to be paid in 10 years
                                                10% Stated interest (annual coupon)
                       
      The bond will pay $100 interest ($1,000 MV * 10% stated) – the amount of
         interest paid is in the bond contract and does not change
 
      The investor varies the rate of return they earn by what they are willing to pay. 
         Whatever percent the investor earns is the same percent the company really
         incurs in interest expense.   The real rate of return is the market/effective rate.
 
            If pay $1,000, actually earn 10%               $100/$1000 = 10%                                                 

             If pay $900, actually earn 11.1%               $100/$900  = 11.1%                                    
 
            If pay $1,100, actually earn 9.1%              $100/$1100 = 9.1%
 
In most cases, the cash exchanged will not be equal to the maturity value because the market rate does not equal the stated (coupon) rate.  This creates a: 
 
     Discount:    Cash exchanged is less than face value

     Premium:    Cash exchanged is more than face value


Regardless of what is paid at the beginning, the face value must be paid on the
   maturity date.
 
The actual bond market the bonds trade on determine the acceptable market rate that
 investors are willing to invest to earn.   The market / effective rate changes every day.
   The stated coupon rate does not change.
 
 
 
Determining the price of the bond:
 
Bonds trade on the open market at a percent of maturity value.
 
            A bond that trades at 98 means:  98% (.98) x the maturity value is paid
 
                        For a $300,000 maturity value bond priced at 98, the investor pays
                          $294,000  ($300,000 x .98)
 
                        For a $200,000 maturity value bond priced at 125.75, the investor pays
                          $251,500  ($200,000 x 1.2575, move the decimal point over 2 places)
 
 
Note:  Most Financial Accounting professors will not have you calculate the price of
           the bond and the bond price will be given to you as a number % or total amount. 
 
 
If the bond price is not stated, it can be calculated using the effective interest rate,
     the number of periods until maturity, and the coupon rate.
 
                Total periodic coupon payment**   x   present value factor of an annuity
                                             +
                Maturity value   x     present value factor of a single amount
 
            = Amount paid now to get the effective interest rate return on your money
 
 
    ** Periodic coupon payment = Maturity Value x coupon % / number of payments
                                                                                                                  per year
 
            Use the PV tables to get the factor for the total number of cash payments the
             bond will make (years to maturity x payments each year) and the
             effective / market interest rate.
 
 
 
 
Journal Entries related to the bond payable:
 
The amount received is the cash that is exchanged between the investor and the company.   This is often called “issuing a bond”, which means borrowing money.  

 
Issue Bonds – Premium:                          Issue Bonds – Discount: 
 Cash received > MV                                  Cash received < MV
 
Issue:
 

Cash                                                                          Cash
             Premium                                                        Discount
             Bond Payable (MV)                                                 Bond Payable (MV)
 
 
Interest paid:

Interest Expense                                                      Interest Expense
Premium                                                                                Discount
             Cash                                                                         Cash
 
 
 
Amortization Table:
 
Use an “Amortization Table” to determine how much of the cash payment is interest expense and how much is a discount or premium.  The interest expense uses the effective/market yield rate and the cash paid is from the coupon rate.  These two rates are most likely different.
______________________________________________________________________
 
Effective             Coupon                                 Discount or                    Amount owed-
Interest Exp.   -   Interest     =   Difference        Premium       + / -        “Carrying value”
                                                                                                      
   “Yield %”         “Stated %” or                                                              Begin with the price

         “Market %”       “coupon %”                                                         of the bond The                                                                                                              cash exchanged
   x the last                 x MV                                                                         (not the MV)
   amount owed    (same for
                                all periods)
 
 
 
    Interest                   Cash              Discount or                                 End with the
   Expense                                         Premium                                       maturity value
 
 
 
 
 
 
Long – Term Installment Loans / Notes Payable / Mortgage Payable:
 
 
Borrow money from bank
  Repay in equal payments.
 
            The payments must cover interest expense and repayment of principle
 
                       
   You must determine how much of the payment is for interest expense and how much
      is for repayment of loan.               We use and amortization schedule for this:
 
 
            Example:  You borrowed $800,000 at 10% and your annual payment is $89,750.
 
Payment
Interest 10%
Difference:
to repay principle
Amount Owed
(Carrying Value)
$800,000
1)
$89,750
$80,000
$9,750
$790,250
2)
$89,750
$79,025
$10,725
$779,525

                       
 
Journal entries:
 

Borrow:                          
 
            Cash                          $800,000                  
                        Note Payable              $800,000   
                                               
Interest – 1st year payment
 
            Interest Expense      $80,000
            Note Payable            $  9,750
                        Cash                          $89,750
 
Interest – 2nd year payment
 
            Interest Expense      $79,025
            Note Payable            $10,725
                        Cash                          $89,750

 


 

 

 

 
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