Lecture18 - Lecture 18 Accounting for Long Term Debt...

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Lecture 18 Accounting for Long Term Debt Issuance of Bonds
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Outline What is a bond? Terminology Effective interest rate method for accounting for a bond issued at: a premium par a discount
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What is a bond? 1) The typical bond contract obligates the borrower to make two kinds of cash payments: i) a single lump-sum payment due on the day that the contract expires. This payment also may be referred to as the " par value" , the " face value ", the " maturity value " or the " principal amount " of the bond. ii) a series of equal payments at regular intervals over the term of the contract. Each of the payments, referred to as " coupon " payments, is determined by the par value of the bond, the coupon rate (also referred to as the nominal, stated, or contractual interest rate) and the number of compounding periods per year: 2) The expiration, or maturity, date specified in the bond contract determines both when the "par value" payment is due, and the number of coupon payments to be made over the remaining term of the agreement. Coupon Payment = Par Value x Nominal (coupon) Rate No. of Coupon Payments per Year
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Terminology Issue Price = Price at which the bond was originally issued = Amount originally received from lenders (bond-holders) at the date of issue (i.e. amount borrowed) = Present value of future maturity payment and coupon payments discounted at the market rate of interest at that time (when the bond was issued) Historical Interest Rate = Interest rate which market (lenders) demanded when bond was issued Interest rates are generally expressed on an annual basis but, for accounting purposes, we want the interest rate for an interest compounding period: Interest Stated Annual Market Rate at issuance Rate = No. of Coupon Payments per Year Current Interest Rate = Interest rate at which the bonds are currently trading in the market
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Terminology Premium (Discount) at Issue = Issue Price Par Value Net Book Value = Par Value + Unamortized Premium (– Unamortized Discount) = Present Value of all remaining future cash flows using the historical interest rate Current Market Value = Present Value of all remaining future cash flows using the current market interest rate Interest Expense (per compounding period) = Net book value at start x Historical Interest Rate per period
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Accounting for Bonds Bonds (and other long-term monetary liabilities) are accounted for using the effective interest method , which requires that the interest expense each period be based on the effective interest rate implicit in the lending arrangement when it was initiated (i.e. the historical market interest rate ).
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Bonds Issued at a Premium To illustrate the effective interest method consider the following example: On January 1, 20x1, Three Dog Nite, Inc. issued bonds having an aggregate maturity (face) value
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Lecture18 - Lecture 18 Accounting for Long Term Debt...

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