Fall 2013_Acc 3100_Ch 14 - 14-1 Chapter14:Bonds Debt is...

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14-1 Chapter 14:  Bonds Debt is reported at the present value of its related cash flows (principal and/or interest payments), discounted at the effective rate of interest at issuance. Periodic interest is the effective interest rate times the amount of the debt outstanding during the interest period. Different types of bonds: Callable bonds, installment bonds, convertible bonds etc
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14-2 Recording Bonds at Issuance On January 1, 2013, Masterwear Industries issued $700,000 of 12% bonds. Interest of $42,000 is payable semiannually on June 30 and December 31. The bonds mature in three years [an unrealistically short maturity to shorten the illustration]. The entire bond issue was sold in a private placement to United Intergroup, Inc., at face amount. At Issuance (January 1) Masterwear (Issuer) Cash 700,000 Bonds payable 700,000 United (Investor) Investment in bonds (face amount) 700,000 Cash 700,000
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14-3 Determining the Selling Price Stated interest rate is: The bonds sells: Below market rate At a discount (Cash received is less than face amount) Equal to market rate At face amount (Cash received is equal to face amount) Above market rate At a premium (Cash received is greater than face amount)
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14-4 Determining the Selling Price On January 1, 2013, Masterwear Industries issued $700,000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years . The market yield for bonds of similar risk and maturity is 14% . The entire bond issue was purchased by United Intergroup. Present Values Interest $ 42,000 × 4.76654 = 200,195 $ Principal $700000 × 0.66634 = 466,438 Present value (price) of bonds 666,633 $ Calculation of the Price of the Bonds Because interest is paid semiannually , the present value calculations use: (a) the semiannual stated rate (6%), (b) the semiannual market rate (7%), and (c) 6 (3 x 2) semi-annual periods. Present value of an ordinary annuity of $1: n = 6 , i = 7 % present value of $1: n = 6 , i = 7 %
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14-5 Bonds Issued at a Discount Masterwear (Issuer) Cash 666,633 Discount on bonds payable 33,367 Bonds payable 700,000 United (Investor) Investment in bonds 700,000 Discount on bond investment 33,367 Cash 666,633
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14-6 Determining Interest –  Effective Interest Method Interest accrues on an outstanding debt at a constant percentage of the debt each period. Interest each period is recorded as the effective market rate of interest multiplied by the outstanding balance of the debt (during the interest period). The bond indenture calls for semiannual interest payments of only $42,000 – the stated rate (6%) times the face value of $700,000. The difference ($4,664) increases the liability and is reflected as a reduction in the discount (a contra-liability account). Interest is recorded as expense to the issuer and revenue to the investor. For the first six-month interest period the amount is calculated as follows: $666,633 × (14% ÷ 2) = $46,664 Outstanding Balance Effective Rate Effective Interest
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14-7 Recording Interest Expense The effective interest is calculated each period as the market rate times the amount of the debt outstanding during the interest period.
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