Ch14 Bonds.and.Long Term Notes

14-1 WELCOME TO MY CLASS 14-2 Chapter 14 Bonds and Long-Term Notes 14-3 Learning Objectives Identify the underlying characteristics of debt instruments and describe the basic approach to accounting for debt 14-4 Bonds At Bond Issuance Date Company Company Issuing Issuing Bonds Bonds Bond Selling Price Bond Certificate Investor Investor Buying Buying Bonds Bonds Subsequent Periods Company Company Issuing Issuing Bonds Bonds Interest Payments Face Value Payment at End of Bond Term Investor Investor Buying Buying Bonds Bonds 14-5 The Bond Indenture The indenture is the written specific promises made by the company to the bondholders Debenture Bond secured by the “full faith and credit” of company Mortgage Bond secured by lien on specific real estate owned by the issuer The specific promises made to bondholders are described in a document called a bond indenture Coupon Bond pays Callable Bond interest when allows company to investor submits buy back attached coupon outstanding bonds 14-6 Bonds Interest 10% 6/30 & 12/31 Face Value $1,000 BOND PAYABLE Bond Date 1/1/06 Maturity Date 12/31/15 Face value (maturity or par value) Maturity Date Stated Interest Rate Other Factors: Interest Payment Dates Market Interest Rate Bond Date Issue Date 14-7 Learning Objectives Account for bonds issued at par, at a discount, or at a premium, recording interest at the effective rate or by the straight-line method 14-8 Determining the Selling Price 14-9 Recording Bonds at Issuance On On 1/1/06, 1/1/06, Matrix, Matrix, Inc Inc issues issues 1,000 1,000 bonds bonds at at face face value value to to Apex, Apex, Inc Inc The The market market interest interest rate rate is is 10% 10% The The bonds bonds have have the the following following terms: terms: Face Face Value Value == $1,000 $1,000 Maturity Maturity Date Date == 12/31/10 12/31/10 (5 (5 years) years) Stated Stated Interest Interest Rate Rate == 10% 10% Interest Interest Dates Dates == 6/30 6/30 & & 12/31 12/31 Bond Bond Date Date == 1/1/06 1/1/06 Record the issuance of the bonds on 1/1/06 14-10 Recording Bonds at Issuance Matrix, Inc - Issuer Apex, Inc - Investor 14-27 Debt Issue Costs Record issue cost: Debt issue cost…………… xxx Cash……………………………… xxx Amortize over the years using straight line: Debt issue expense……… xxx Debt issue cost………………… xxx 14-28 Financial Statement Disclosures Long-Term Debt For all long-term borrowing, disclosures should include the aggregate amounts maturing and sinking fund requirement, if any, for each of the next five years 14-29 Decision Makers’ Perspective Long-term debt impacts several key financial ratios Rate of return on Net income = shareholders’ equity Shareholders’ equity Times interest Net income + interest + taxes earned ratio = Interest Debt to Total liabilities = equity ratio Shareholders’ equity Rate of return = Net income on assets Total assets 14-30 Learning Objectives Record the early extinguishment of debt and its conversion into equity securities 14-31 Early Extinguishment of Debt Debt Debt retired retired at at maturity maturity results results in in no no gains gains or or losses losses BUT Debt Debt retired retired before before maturity maturity may may result result in in an an gain gain or or loss loss on on extinguishment extinguishment Cash Cash Proceeds Proceeds –– Book Book Value Value == Gain Gain or or Loss Loss 14-32 Early Extinguishment of Debt (p.820, Ex: 14-7) 14-33 Convertible Bonds Some bonds may be converted into common stock at the options of the holder When bonds are converted the issuer updates interest expense and amortization of discount or premium to the date of conversion The bonds are reduced and shares of common stock are increased Bonds into Stock 14-34 Convertible Bonds The Book Value Method Record new stock at the book value of the convertible bonds No gain or loss is recognized On December 31, 2006, all of the bondholders of Matrix, Inc convert their bonds into common stock There are 10,000 bonds outstanding with a face value of $1,000 each Each bond is convertible into 50 shares of the company’s $1 par value common stock There is $1,500,000 on unamortized discount associated with the bonds that are converted Interest and discount amortization have been brought up to December 31 Let’s look at the entry to record the conversion 14-35 Convertible Bonds 10,000 × 50 shares × $1 par value The carrying value of the bonds is assigned to the stock 14-36 Bonds with Detachable Warrants  Stock warrants give the investor an option to purchase a stated number of shares at a specified price within a specified period of time  The issue price is allocated between the bonds and the warrants using market values Bonds with Detachable Warrants Ex: Illustration 14-19, p.823 14-37 Bonds with Detachable Warrants Ex: Illustration 14-19, p.823 If one-half of the warrants (1 million) are exercised when the market value of HTL’s common stock (1$ par) is $30 per share, how we record? - Cash (1,000,000 warrants × $25) 25 Equity—stock warrants (1,000,000 warrants × $3) Common stock (to balance) PIC, exceed par ……………… ………………27 14-38 Bonds with Detachable Warrants Ex: Illustration 14-19, p.824 At Issuance At Exercise 14-39 14-40 Remember     Read the text book Do all examples in text book Do Review Exercise Do homework 14-41 End of Chapter 14 ...14-2 Chapter 14 Bonds and Long -Term Notes 14-3 Learning Objectives Identify the underlying characteristics of debt instruments and... interest interest rate rate is is 10% 10% The The bonds bonds have have the the following following terms: terms: Face Face Value Value == $1,000 $1,000 Maturity Maturity Date Date == 12/31/10 12/31/10... Investor 14-11 Determining the Selling Price On 1/1/06, Matrix, Inc issues 1,000 bonds at face value to Apex, Inc The market interest rate is 12% The bonds have the following terms: Face Value