click to edit master title style 1 1 1 15 bonds payable

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15Bonds PayableBonds Payable


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Financing Corporations 15-1

A bond is simply a form of an interest-bearing note. Like a note, a bond requires periodic

interest payments, and the face amount must be repaid at

the maturity date.


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15-2

Bonds Payable

A corporation that issues bonds enters into a contract (called a bond indenture or trust indenture) with the bondholders.

Usually, the face value of each bond, called the principal, is $1,000 or a multiple of $1,000.

Interest on bonds may be payable annually, semiannually, or quarterly. Most pay interest semiannually.


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When all bonds of an issue mature at the same time, they are called term bonds.

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If the maturity dates are spread over several dates, they are called serial bonds.

Bonds that may be exchanged for other securities are called convertible bonds.


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Bonds issued on the basis of the general credit of the corporation are debenture bonds.

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Bonds that a corporation reserves the right to redeem before their maturity are called callable bonds.

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Pricing of Bonds Payable

When a corporation issues bonds, the price that buyers are willing to pay depends upon three factors:

1. The face amount of the bonds, which is the amount due at the maturity date.

2. The periodic interest to be paid on the bonds. This is called the contract rate or the coupon rate.

3. The market or effective rate of interest.


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15-2

The market or effective rate of interest is determined by transactions between buyers and sellers of similar bonds. The market rate of interest is affected by a variety of factors, including:1. investors assessment of current economic

conditions, and2. future expectations.


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MARKET RATE = CONTRACT RATE

Selling price of bond = $1,000

$1,00010% payable

annually

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If the contract rate equals the market rate of interest, the bonds will sell at their face amount.


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MARKET RATE > CONTRACT RATE

Selling price of bond < $1,000

–Discount

$1,00010% payable

annually

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If the market rate is higher than the contract rate, the bonds will sell at a discount.


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MARKET < CONTRACT RATE

Selling price of bond > $1,000

+Premium

$1,00010% payable

annually

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If the market rate is lower than the contract rate, the bonds will sell at a premium.


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On January 1, 2007, a corporation issues for cash $100,000 of 12%, five-year bonds; interest payable

semiannual. The market rate of interest is 12%.

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Issued $100,000 bonds

payable at face amount.

Bonds Payable 100 000 00

Jan. 1 Cash 100 000 002007


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On June 30, an interest payment of $6,000 is made ($100,000 x .12 x 6/12).

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June 30 Interest Expense 6 000 00

Cash 6 000 00

Paid six months’ interest on

bonds.


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The bond matured on December 31, 2011. At this time, the corporation paid

the face amount to the bondholder.

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Cash 100 000 00

Paid bond principal at

maturity date.

Dec. 31 Bonds Payable 100 000 002011


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Since the payment of bonds normally involves a large amount

of cash, a bond indenture may require that cash be periodically transferred into a special cash

fund, called a sinking fund, over the life of the bond issue.

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Bond Redemption 15-4

A corporation may call or redeem bonds before they mature. Callable

bonds can be redeemed by the issuing corporation within the

period of time and the price stated in the bond indenture. Normally, the call price is above the face value.


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Bonds may be purchased either directly from the issuing corporation or through an

organized bond exchange. Prices for bonds are quoted as a

percentage of the face amount.

Accounting for Bond Investments 15-5


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On April 2, 2007, an investor purchases a $1,000 Lewis Company bond at 102 plus a brokerage

fee of $5.30 and accrued interest of $10.20.

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Cash1 035 50

Apr. 2 Investment in Lewis Co. Bonds 1 025 302007

Interest Revenue 10 20

Invested in a Lewis Company

bond.


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Cash1 035 50

Apr. 2 Investment in Lewis Co. Bonds 1 025 302007

Interest Revenue 10 20

Invested in a Lewis Company

bond.

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On April 2, 2007, an investor purchases a $1,000 Lewis Company bond at 102 plus a brokerage

fee of $5.30 and accrued interest of $10.20.

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Note that the brokerage fee is added to the cost of the investment.


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15-5

On July 1, 2007, Crenshaw Inc. purchases $50,000 of 8% bonds of Deitz Corporation due in 8 3/4 years. The effective interest

rate is 11%. The purchase price is $41,706 plus interest of $1,000 accrued from April

1, 2007 ($50,000 x 8% x 3/12).

Extended Illustration for Crenshaw, Inc.


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Interest Revenue 1 000 00

Cash 42 706 00

Purchased investment

in bonds, plus accrued

interest.

July 1 Investment in Deitz Corp. Bonds 41 706 002007

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The entry to record the investment is as follows:


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Crenshaw, Inc. received semiannual interest for April 1 to October 1 ($50,000 x 8% x 6/12).

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Received semiannual

interest for April 1 to

October 1.

Oct. 1 Cash 2 000 00


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Adjusting entry for interest accrued from October 1 to December 31 ($50,000 x 8% x 3/12).

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Dec. 31 Interest Receivable 1 000 00

Adjusting entry for interest

accrued from October 1 to

December 31.


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Balance Sheet of a Corporation

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(Continued)

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Balance Sheet of a Corporation

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(Concluded)

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Held-to-Maturity Securities

Investments in bonds or other debt securities that management intends to hold to their maturity are called

held-to-maturity securities.


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Such securities are classified as long-term investments under the caption Investments.

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These investments are reported at their cost less any amortized premium or plus any amortized discount.

The market (fair) value of the bond investment should be disclosed, either on the face of the balance sheet or in an accompanying note.

Balance Sheet Presentation of Bond Investments

click to edit master title style 1 1 1 15 bonds payable

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