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Accounting2011Notes

# Straight line method amortization the same each period

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Unformatted text preview: Rate Coupon rate < effective rate – Proceeds to company < bond face value Coupon rate > effective rate – Proceeds to company > bond face value Coupon rate = effective rate – Proceeds to company = bond face value Other Characteristics Callable feature – Option of the company Convertible feature Retractable feature – Option of the purchaser Restrictive covenants Pricing of Bonds Price equals PV of cash flow to buyer Discount rate is equal to market rate Cash flow is interest and principal PV of interest stream + PV of principal = Proceeds on issuance of bond Bonds Sold at a Discount Principal amount \$5,000,000, five years Coupon rate 9% paid semi- annually Effective rate 10% (market conditions) – PV interest = PVA 5, 10 = 225,000 x 7.72173 – PV principal = PV 5, 10 = 5,000,000 x 0.61391 – Price = \$1,737,389 + \$3,069,550 Proceeds = \$4,806,939 Bonds Sold at a Premium Principal amount \$5,000,000, five years Coupon rate 9% paid semi- annually Effective rate 8% (market conditions) Jessica Gahtan ACTG2011 Page 9 Final Notes Chapters 8- 12 Fall 2013 – PV interest = PVA 4, 10 = 225,000 x 8.11090 – PV principal = PV 4, 10 = 5,000,000 x 0.67556 – Price = \$1,824,953 + \$3,377,800 Proceeds = \$5,202,753 Bonds Sold at Par Principal amount \$5,000,000, five years Coupon rate 9% paid semi- annually Effective rate 9% (market conditions) – PV interest = PVA 4.5, 10 = 225,000 x 7.91272 – PV principal = PV 4.5, 10 = 5,000,000 x 0.64393 – Price = \$1,780,362 + \$3,219,650 Proceeds = \$5,000,000 (rounding) Accounting for Bonds Bond discount or premium – Must be reduced to zero by time of maturity Two methods to amortize – Straight line method (acceptable by PE GAAP or if not material) – Effective interest method ** Note: PE GAAP – CICA 3856 does not require the use of the effective interest rate method. Straight- line Method Amortization the same each period – Amortization divided by number of periods Interest expense the same each period – Over life equals interest payments plus premium or minus discount Effective Interest Method Amortization changes each period – Difference between interest expense and cash payment of interest Interest expense changes each period – Book value of bonds times effective interest rate Bonds Sold at Par Proceeds on sale – Dr. Cash \$5,000,000 – Cr. Bonds payable \$5,000,000 Pay interest on a semi annual basis – Dr. Interest expense \$225,000 – Cr. Cash \$225,000 Pay principal at maturity – Dr. Bonds payable \$5,000,000 Jessica Gahtan ACTG2011 Page 10 Final Notes Chapters 8- 12 Fall 2013 – Cr. Cash...
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