Accounting 21th waren reeve fess chapter 15

Chapter 15 Bonds Payable and Investments in Bonds Accounting, 21st Edition Warren Reeve Fess PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning All rights reserved Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc Some Some of of the the action action has has been been automated, automated, so so click click the the mouse mouse when when you you see see this this lightning lightningbolt bolt in in the the lower lower right-hand right-hand corner corner of of the the screen screen You You can can point point and and click click anywhere anywhere on on the the screen screen Objectives Objectives Compute the potential impact of longAfter this After studying studying this term borrowing on the earnings per chapter, you should chapter, you share of a corporation.should be able to: be able to: Describe the characteristics of bonds Compute the present value of bonds payable Journalize entries for bonds payable Describe bond sinking funds Objectives Objectives Journalize entries for bond redemptions Journalize entries for the purchase, interest, discount, and premium amortization, and sale of bond investments Prepare a corporation balance sheet Compute and interpret the number of times interest charges are earned Two Two Methods Methods of of Long-Term Long-Term Financing Financing Resources = Sources Liabilities Debt Financing: Bondholders Assets Stockholders’ Equity Equity Financing: Stockholders Two Two Methods Methods of of Long-Term Long-Term Financing Financing Bondholders Stockholders Why issue bonds rather than stock? Bonds (debt)—Interest payments to bondholders are an expense that reduces taxable income Stock (equity)—Dividend payments are made from after tax net income and retained earnings Earnings per share on common stock can often be increased by issuing bonds rather than additional stock Alternative Financing Plans – $800,000 Earnings Plan 12 % bonds $2,000,000 Preferred 9% stock, $50 par 1,000,000 Common stock, $10 par 1,000,000 Total $4,000,000 Earnings before interest and income tax $ 800,000 Deduct interest on bonds 240,000 Earnings per share Income before income tax $ 560,000 Deduct income tax $ 2.46 Plan Plan — — — $2,000,000 $4,000,000 2,000,000 $4,000,000 $4,000,000 $ 800,000 $ 800,000 — — 1.20 $ 800,000 $ 1.50 $ 800,000 320,000 320,000 $ Alternative Financing Plans – $440,000 Earnings Plan 12 % bonds $2,000,000 Preferred 9% stock, $50 par 1,000,000 Common stock, $10 par 1,000,000 Total $4,000,000 Earnings before interest and income tax $ 440,000 Deduct interest on bonds 240,000 Earnings per share Income before income tax $ 200,000 Deduct income tax $ 0.30 Plan Plan — — — $2,000,000 $4,000,000 2,000,000 $4,000,000 $4,000,000 $ 440,000 $ 440,000 — — 0.66 $ 440,000 $ 0.42 $ 440,000 176,000 176,000 $ Characteristics Characteristics of of Bonds Bonds Payable Payable  A bond contract is called a bond indenture or trust indenture  Long-term debt—repayable 10, 20, or 30 years after date of issuance  Issued in face (principal) amounts of $1,000, or multiples of $1,000  Contract interest rate is fixed for term (life) of the bond  Face amount of bond repayable at maturity date Investments Investments in in Bonds Bonds On On April April 2, 2, 2005, 2005, Purchased Purchased aa $1,000 $1,000 Lewis Lewis Company Company bond bond at at 102 102 plus plus aa brokerage brokerage fee fee of of $5.30 $5.30 and and accrued accrued interest interest of of $10.20 $10.20 2005 Apr in LewisInterest Co Bonds Revenue Investment 1100252030 Cash 035 50 Invested in a Lewis Company bond Note that the brokerage fee is added to the cost of the investment Investments Investments in in Bonds Bonds To To assist assist your your understanding, understanding, let’s let’s look look at at an an extended extended illustration illustration for for Crenshaw, Crenshaw, Inc Inc Investments Investments in in Bonds Bonds On On July July 1, 1, 2005, 2005, Crenshaw CrenshawInc Inc purchases purchases $50,000 $50,000 of of 8% 8% bonds bonds of of Deitz Deitz Corporation Corporation due due in in 88 3/4 3/4 years years The The effective effective interest interest rate rate isis 11% 11% The The purchase purchase price price isis $41,706 $41,706plus plus interest interest of of $1,000 $1,000accrued accrued from from April April 1, 1, 2005 2005 2005 July in Deitz Corp Bonds Interest Revenue Cash 42 706 00 Purchased investment in bonds, plus accrued interest Investment 41 706 00 000 00 $50,000 x 8% x 3/12 Investments Investments in in Bonds Bonds Received Received semiannual semiannual interest interest for for April April 11 to to October October 11 ($50,000 ($50,000 xx 8% 8% xx 6/12) 6/12) Oct 00 Cash 000 Interest Revenue 000 00 Received semiannual interest for April to October Investments Investments in in Bonds Bonds Adjusting Adjusting entry entry for for interest interest accrued accrued from from October October 11 to to December December 31 31 ($50,000 ($50,000 xx 8% 8% xx 3/12) 3/12) Dec 31 Interest Receivable Interest Revenue 000 00 Adjusting entry for interest accrued from October to December 31 000 00 Investments Investments in in Bonds Bonds Adjusting Adjusting entry entry for for amortization amortization of of discount discount for for July July 11 to to December December 31: 31: ($50,000 ($50,000 –$41,706)/105 –$41,706)/105 xx 66 months months Dec 31 in Deitz Corp.Interest BondsRevenue 474 00 Adjusting entry for amortization of discount from July to December 31 Investment 474 00 Rounded to nearest dollar ($79 a month) Investments Investments in in Bonds Bonds Investment Revenue July 1,000 Oct 2,000 Dec 31 1,000 Bal 2,474 31 474 3,474 Investments Investments in in Bonds Bonds The The Deitz Deitz bonds bonds are are sold sold on on June June 30, 30, 2012 2012 for for $47,350 $47,350 plus plus accrued accrued interest interest ItIt has has been been six six months months since since the the last last amortization amortization entry, entry, so so amortization amortization for for the the current current year year must must be be recorded recorded (6 (6 months) months) 2012 June 30 in Deitz Corp Bonds Interest Revenue 474 00 Amortized discount for current year Investment 474 00 $79 x Investments Investments in in Bonds Bonds Investment in Deitz Corporation Bonds 2005 July 41,706 2006 Dec 31 2007 474 2008 Dec 31 2009 948 2010 Dec 31 2011 948 2012 31 Dec 948 Dec 31 948 The investment $79 x account after all $79 x 12 amortization entries have been made, including the June 30, 2012 adjusting entry Investments Investments in in Bonds Bonds This This investment investment was was sold sold on on June June 30, 30, 2009 2009 for for $47,350 $47,350 plus plus accrued accrued interest interest ItIt has has been been six six months months since since the the last last amortization amortization entry, entry, so so amortization amortization for for the the current current year year $50,000 must must be be recorded recorded (6 (6 months) months) x 8% x 3/12 2012 June 30 350 00 Cash 48 LossInterest on SaleRevenue of Investment 000 00 Investment in Deitz Corp Bonds 48 342 00 992 00 Financial Analysis and Interpretation Number Number of of Times Times Interest Interest Charges Charges Earned Earned Solvency Measures—The Long-Term Creditor Number Number of of Times Times Interest Interest Charges Charges Earned Earned 2006 2005 $ 900,000 Income before income tax $ 800,000 Add interest expense 300,000 250,000 Income before income tax + Interest expense Amount available for interest $1,200,000 Interest Expense $1,050,000 2005 2005 $800,000 + $250,000 = 4.2 times $250,000 Solvency Measures—The Long-Term Creditor Number Number of of Times Times Interest Interest Charges Charges Earned Earned 2006 2005 $ 900,000 Income before income tax $ 800,000 Add interest expense 300,000 250,000 Income before income tax + Interest expense Amount available for interest $1,200,000 Interest Expense $1,050,000 2006 2006 $900,000 + $300,000 = 4.0 times $300,000 The The purpose purpose of of the the ratio ratio isis to to assess assess the the risk risk to to debtholders debtholders in in terms terms of of number number of of times times interest interest charges charges were were earned earned Chapter 15 The The End End ... impact of longAfter this After studying studying this term borrowing on the earnings per chapter, you should chapter, you share of a corporation.should be able to: be able to: Describe the characteristics... payments of 10% compounded annually: $100 x 1.73554 (PV of annuity of $1 for years at 10%) 173.55 Accounting Accounting for for Bonds Bonds Payable Payable Bonds Issued at Face Amount On January 1, 2005,... $6,000 x 7.3609 (PV of annuity of $1 for 10 periods at 6%) 44,160 Total present value of bonds Accounting Accounting for for Bonds Bonds Payable Payable Bonds Issued at Face Amount On January 1, 2005,