Periodic interest is calculated as the
effective interest rate times the amount of the debt
outstanding during the period
This same principle applies to the flip side of the transaction, i.e.,
the creditor’s receivable or investment.
The approach also is the same regardless of the specific
form of the debt – that is, whether in the form of notes, bonds, leases, pensions, or other debt
Long-term liabilities are appropriately reported at their
The present value of
a liability is the present value of its related cash flows – specifically the present value of the face
amount of the debt instrument, if any, plus the present value of stated interest payments, if any.
Both should be discounted to present value at the effective (market) rate of interest at issuance.
Bonds and notes are very similar.
obligate the issuing corporation to repay a
stated amount (e.g., the
) at a specified
In return for the use of the money borrowed, the company also agrees to pay
to the lender between the issue date and maturity.
The periodic interest is a stated
percentage of face amount.
In concept, bonds and notes are accounted for in precisely the same
Normally a company will borrow cash from a bank or other financial institution by signing a
Corporations, especially medium- and large- sized firms, often choose to
borrow cash by issuing bonds, instead.
A bond issue, in effect, breaks down a large debt into
manageable parts ($1,000 units).
Also, bonds typically have longer maturities than notes.
most common form of corporate debt is bonds.
All of the specific promises made to bondholders are described in a bond indenture.
formal agreement will specify the bond issue’s face amount, the stated interest rate, the method
of paying interest (whether the bonds are registered bonds or coupon bonds), whether the bonds
are backed by a lien on specified assets, and whether they are subordinated to other debt.
bond indenture also might provide for their redemption through a call feature, by serial
payments, through sinking fund provisions, or by conversion.
It also will specify the trustee
(usually a commercial bank or other financial institution) appointed by the issuing firm to
represent the rights of the bondholders.
The bond indenture serves as a contract between the
company and the bondholder(s).
If the company fails to live up to the terms of the bond
indenture, the trustee may bring legal action against the company on behalf of the bondholders.
BONDS AND LONG-TERM NOTES
Questions for Review of Key Topics