Handout 09 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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Copyright © 2011 1 You may only share these materials with current term students. I NTRODUCTION TO F INANCIAL A CCOUNTING 33:010:272 S ECTIONS 08 09 |FALL 2011 P ROFESSOR J ULIAN Y EO Class Notes 9: Liabilities - Bonds In this handout, we begin by first defining what liabilities are. We then examine the accounting treatments for bonds. Understanding how to account for bonds is crucial in understanding why the book value of liabilities approximates the market value of liabilities (and limitations of that statement). Specifically, we address the following questions: 1. What are liabilities? 2. How do we account for Bonds? 3. What are the accounting treatments for retirement of bonds? 4. What is the fair value option for financial liabilities (and financial assets)? 5. How do bond-related transactions affect the Statement of Cash Flows? Learning objectives Upon the completion of this topic, you should be able to: Use terminologies commonly used for bonds o Face Value, Coupon Rate, Market (Effective) Rate of Interest o Par/Discount/Premium Understand how bonds should be reported on Balance Sheet, Income Statement, and Statement of Cash Flows Familiar with Accounting Rules for bonds: o Int t = BV t-1 * r , BV t = CF i i = t T (1 + r ) ( i t ) , Int t = Payment t + BV t - BV t-1 Able to make journal entries related to bonds Understand the accounting treatment for retirement of bonds o Gains on Retirement of Bonds Aware of the fair value option for financial assets and financial liabilities. Understand how bond-related transactions affect the Statement of Cash Flows
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Copyright © 2010 2 You may only share these materials with current term students. 1. What are liabilities? Definition : Liability - a present obligation of the enterprise arising from past events, the settlement of which is expected to result in a probable future outflow from the enterprise of resources embodying economic benefits. Current (short term) liabilities - maturity within one year (or within the operating cycle). Long-term liabilities - all other liabilities. 2. How do we account for Bonds? A bond defines the timing and the magnitude of future cash outflows. When a bond is issued, investors pay a market price , which reflects the expected payoffs that they will receive and the risk that they are bearing for owning the bond (e.g., payoffs include the periodic payments and principal they will receive; risk factors include firm specific items like covenants or liquidity predictions and market wide items like interest rates and inflation). The market price of the bond may be different from the face value of the bond. When market price < face value, bonds sell at a discount. When market price > face value, bonds sell at a premium.
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Handout 09 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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