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UCLA / Business Management / MGMT 1 / business management 1b

business management 1b

business management 1b

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School: University of California - Los Angeles
Department: Business Management
Course: Principles of Accounting
Professor: Ravetch
Term: Summer 2015
Tags:
Cost: 50
Name: Management 1B- Midterm 1 Study Guide
Description: Management 1B- Midterm 1 Study Guide
Uploaded: 02/01/2017
18 Pages 194 Views 0 Unlocks
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If we were to distribute a dividend equal to net income, how much would each share of common stock receive?




If we were to liquidate the corporation at its book value, how much would each share of common stock receive?




Why would a company repurchase its own stock?



Monday, January 30, 2017 Management 1B: Midterm 1 Study Guide  First Day Notes  I. Users:  A. Creditors: how big a risk you are  B. Investors: determine when to buy and when to sell  C. Management:We also discuss several other topics like él/ella/usted
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to help them make decisions  D. Government: GAO, IRS  E. Regulatory Agencies  F. Advisors  II. Careers in Accounting  A. Industry (Disney, Google, Microsoft, Apple)  B. Government  C. Banking (Investment, Retail, Commercial)  D. Public Accounting  III. Public Accounting  A. Taxation (or tax planning)  B. Consulting: telling companies how they can be better  C. Auditing: verifying  IV. CPA  A. Education: 5th year of education (AP credit, summer classes, CC)  B. Experience: work for 1 year under CPA  C. Quiz: CPA Exam  V. Accounting Minor  VI. Two Movements in accounting  A. Away from Historical Cost to Fair Value  1. Historical Cost: what we pay for things  B. Convergence between US GAAP (FASB) and IFRS (IASB)  1Monday, January 30, 2017 1. IFRS: International Financial Reporting System  VII.Qualitative Characteristics of Financial Information  A. Relevancy: information is relevant if it influences actions of decision makers.  B. Reliability: information accurately depicting conditions its purported to represent.  C. Comparability: Usefulness is enhanced if we can compare our financial statement with  prior year financial statements and with other companies’ financial statements.  D. Consistency: We should apply the same accounting principles every year. We are allowed  to change methods, but we must state the reason for the change and the effect of the  change.  VIII. GAAP (Generally Accepted Accounting Principles)  A. Entity: A company is an economic unit separate and distinct from the owners.  B. Going Concern: We assume that a company will continue to operate indefinitely.  C. Periodicity: We cannot wait forever to evaluate performance.  1. Accounting Period: Usually one year or operating cycle whichever is longer 2. Operating Cycle: “Cash to Cash” D. Monetary Unit: Everything measured in dollars. Assuming inflation is insignificant. E. Objectivity: Accounting information must be free from bias and verifiable by an  independent party. F. Historical Cost: We record the acquisition of goods, services, and other resources at their  exchange price. We capitalize these costs (put them into an asset account) and expense  them over the period in which we benefit from them.  1. Capitalize = Asset  2. FB = Future Benefit  3. Capitalize when there is future benefit, Expense if no future benefit  4. Capitalize, then Depreciate over its life span  G. Full Disclosure: Everything that is relevant must be disclosed in the financial statements  and/or in the notes to the financial statements.  H. Substance Over Form (not in the textbook): When the economic substance of a  transaction differs from the legal form, accountants emphasize the economic substance.  1. “Don’t judge a book by its cover.”  2Monday, January 30, 2017 2. Application: Disney and Pixar I. Revenue Recognition: When is revenue recorded in the financial statements? 1. For many situations...  a) At the Point of Sale (When they complete their part).  b) Accrual Accounting.  2. New Revenue Recognition to go into effect for reports issued after December 15,  2016.  a) Contract Method  (1) Identify the contract with the customer  (2) Identify the performance obligation(s) in that contract  (3) Determine the transaction price  (4) Allocate that transaction price to each performance obligation  (5) Recognize revenue when (or as) each performance obligation is satisfied  3. Percentage of Completion: Long Term Construction Contracts  a) Given: Sales Price, Estimated Cost, Estimated Profit  b) Profit Each Year = % of Work Completed x Total Profit  4. Installment Sales: Used if collection is not assured  a) Gross Profit % = Gross Profit / Sales  b) Profit Recognized = Cash Received x Gross Profit %  IX. When are costs expensed? (Cost- Acquisition of goods, services, and other resources)  A. Matching Principle: Costs incurred to generate revenues are expensed in the same period  as the revenue is recognized (Matching: need both)  1. Costs of Goods Sold  2. Bad Debt Expense  3. Warranties  B. Systematic and Rational Allocation (Expense it over long period of time)  1. Depreciation: for tangible assets  2. Amortization: for intangible assets  3Monday, January 30, 2017 3. Prepaid  C. Immediate Recognition  1. Research and Development: expensed immediately  2. Costs with no Future Benefits: utilities  X. Materiality: Relative Significance: “One person’s trash is another person’s treasure”.  XI. Conservatism: Accounting measurements take place in a context of significant uncertainty.  Possible errors in measurement should tend toward understatement, rather than  overstatement, of assets and income. (Don’t overstate assets/income)  A. Accounts Receivable  B. Litigation: lawsuit  Partnership Notes  Partnerships: Voluntary Association of two or more person conducting a business for profit. XII.Characteristics  A. Ease of Formation: A verbal agreement is sufficient.  B. Articles of Partnership: The who, what, where, when, why, and how of partnerships—all  the agreed upon details of a partnership (Written Contract Ideal).  C. No Separate Legal Entity: Legally, there is no difference between a partnership and the  partners. D. Unlimited Liability: Partners are jointly and severally liable for all liabilities of the  partnership without limit.  E. Mutual Agency: Each partner is an agent (representative) of the partnership. F. Co-ownership of property: All assets contributed to the partnership become jointly  owned by all partners. The assets should be entered into the partnership records at their  fair market value. G. Profit and Loss: The partners may allocate profit and loss in any way they choose. In the  absence of an agreement, profits are divided equally.  H. Limited Life: If a new partner enters into the partnership or if an existing partner leaves  the partnership, the old partnership is dissolved and a new one is formed. Usually  business will continue without interruption. I. Other Advantages: 4Monday, January 30, 2017 1. A partnership is an easy way to bring together individuals with varied resources. 2. There are very few reporting requirements.  3. There is less governmental regulation.  J. LLP — Limited Liability Partnership: A special form of a partnership in which the  unlimited liability rule is applied to the partners “at fault.” 1. Only Limited Partners: limited liability (No General Partners)  K. Limited Partnership: A special form of partnership where there is at least one general  partner (Unlimited liability) and at least one limited partner (Stockholder).  1. General Partners: unlimited liability  2. Limited Partners: limited liability  L. Taxes: A partnership is not a taxable entity. However, the partners are taxed on their  portions of partnership earnings. M. Master Limited Partnership: Has at least one general partner and one limited partner. A  type of limited partnership that is publicly traded. Must derive most (~90%) of its cash  flows from real estate, natural resources and commodities. Combines the tax benefits of a  partnership with the liquidity of a publicly traded company. N. Pass Through Entities (Income passes through to the owners’ tax returns, but the  partnership is not taxed.)  1. Sub-Chapter S Corporation: A corporation which after meeting certain requirements  by the IRS can be taxed as a partnership. Restricted to 100 shareholders. There are  other restrictions. If you are making profits in excess of what is a fair salary, there are  tax advantages, here, mainly self-employment taxes.  2. LLC — Limited Liability Company: Sort of a cross between a corporation (limited  liability) and a partnership (profits “pass-through” to shareholders). Form of choice  today for many small businesses. XIII.Formation: All assets and liabilities are recorded at their FMV or NRV. A. FMV: Fair Market Value  B. NRV: Net Realizable Value  XIV.Profit / Loss Distribution XV.Admission to the Partnership  A. Purchase an Interest- from an existing partner  1. Current Capital Balances  5Monday, January 30, 2017 2. 3rd Partner wants 1/2 partnerships interest and is willing to pay the following to each  partner  3. Entry  4. The amount of money that exchanges hands is a personal transaction between the  partners. There is no effect on the partnership as an entity, and consequently, the  exchange of cash is not recorded on the partnership’s records. Only the change in  ownership is recorded. XVI.Retirement: The opposite of Admission  A. Current Capital Balances  B. 3rd Partner leaves the partnerships and is paid out of partnership funds  C. Partners share profits and losses in certain ratio  D. Entry  XVII.Liquidation: Three Steps (SPA)  A. Sell the Assets of the Firm  1. Realization: sale of non cash assets for cash  2. Gain or Loss on Realization: any difference between book value and cash proceeds  B. Pay the Liabilities  C. Allocate the Remaining Cash to Partners  D. Partner’s Capital Balance: The partner’s right to assets on liquidation.  1. Partnership Liquidation: ends both the legal and economic life of the entity  XVIII.Income Ratios  A. Fixed Ratio: proportions or percentages  B. Ratio based on Capital Balances: when funds invested are critical factors  C. Other Ratios: give specific recognition to differences among partners  XIX.Death of a Partner: dissolves the partnership  A. Determine net income or loss of year to date  B. Close the books  C. Prepare financial statements  6Monday, January 30, 2017 D. Remaining partners may agree to purchases deceases partner’s squirt from personal  assets and settling with deceased partner’s estate  Chapter 11 XX.Characteristics of a Corporation  A. Separate Legal Existence: A corporation is a distinct legal entity. It can be sued and it can  also enter into contracts.  B. Transferability of Ownership: The share of stock is the symbol of ownership. Many  shares may change hands (be bought and sold) without interrupting operations.  C. Perpetual Existence: Shares of stock are bought and sold every day. A corporation  continually exists despite changes in ownership.  D. Limited Liability: With one exception, the most an investor can lose is their investment.  This is different from partnerships where partners have unlimited liability.  E. Ease of Raising Capital: The corporation can sell additional shares of stock or issue  bonds to raise additional funds.  F. Double Taxation: Corporations are taxed on their income because they are separate legal  entities. Stockholders are also taxed on dividends they receive. Thus, the same earnings  are taxed twice.  G. Heavy Regulation: The SEC (Securities and Exchange Commission) is the regulatory  agency for public securities transactions. The SEC does not protect the investor from  losing their investment, but they do their best to protect them from getting incorrect  information. One way that they do this is every year they require publicly-held  corporations to undergo an audit of their annual report. H. Organization: Stockholders —> Board of Directors —> Officers —> Employees  I. Organization Costs: These are the start-up costs of a corporation (legal fees, filing fees,  printing fees, accounting fees, etc.). They are expensed immediately.  J. Sarbanes Oxley: created PCAOB. K. PCAOB – Public Company Accountant Oversight Board XXI.Stockholder’s Equity- Balance Sheet  A. Paid In Capital (PIC) —Contributed Capital  B. Retained Earnings— Earned Capital  XXII.Stock Terms  A. Authorized: The number of shares that we have permission from the state to issue. 7Monday, January 30, 2017 B. Issued: Shares sold, but not retired (these shares may have been repurchased).  C. Treasury Shares: Shares that have been repurchased by the corporation, but not retired.  These are shares that are issued but not outstanding.  D. Outstanding: Issued shares less treasury shares. These are shares that have been issued  but have not been repurchased.  E. Par Value: In the early days of stock investments, par value was the initial selling price of  a share of stock. Today, the par value of stock is often called legal capital, the amount of  stockholders’ equity that can never be returned to stockholders as a dividend. For our  purposes, it will be the amount contained within the common and preferred stock  accounts. The par value amount is printed on the stock certificates.  F. No Par Stock With a Stated Value: Due to confusion with the stock certificates (par value  is a meaningless number when compared to the market value), many companies issue no  par stock, but declare a stated value. For our purposes, we will account for it the same  way as we did par value stock.  G. IPO: Initial Public Offering XXIII.Common Stock Rights- The most typical type of stock issuance.  A. Right to participate in profits: Dividends B. Right to Assets on Liquidation  C. Right to Vote  D. Preemptive Right: If a corporation decides to issue additional shares, previous owners  have the right to keep their same ownership percentage (they have the opportunity to buy  additional shares before any other potential stockholder). XXIV.Preferred Stock (a fixed return investment)—Rights A. Preference over common stock for Dividends and Rights to Assets on Liquidation. 1. Annual Dividend Requirement for Preferred Stock = Total Par Value of Outstanding  Shares X Dividend %. 2. Example: 5% Preferred Stock, 1000,000 shares issued and outstanding, $100 par  value —> Total Par Value = $10 million x 5% = $500,000 B. Preferred shareholders give up Right to Vote and Preemptive Right.  C. Cumulative Preferred Stock—(Most preferred stock is cumulative): Sometimes,  preferred stock does not receive their full annual dividend requirement (some times they  receive nothing at all). In the following year, before common stockholders get a dime,  preferred shareholders would receive the current year’s annual dividend requirement and  the amount from the previous year (a year in arrears).  8Monday, January 30, 2017 D. Reasons to issue preferred stock 1. To raise capital without sacrificing control. 2. To boost the return earned by common stockholders through financial leverage. a) Corporations hope to earn a higher return on the funds invested b) Higher than the dividend rate to preferred stockholders c) Similar to bonds 3. To appeal to investors who may believe the common stock is too risky or that the  expected return on common stock is too low. E. Convertible Preferred Stock: At the stockholder’s option, they have the right to convert  their shares to (usually) shares of common stock.  F. Callable Preferred Stock: At the corporation’s option, the preferred stock may be  repurchased (and retired) at a fixed predetermined price.  XXV.Class Problems- Entries and Stockholders’ Equity of the Balance Sheet  XXVI.Additional Stock Entry- Non Monetary Transaction [Chapter 11 Notes (6)]  XXVII.Review: New Stockholders’ Equity Accounts- all “Paid In Capital” Equity Accounts  A. Preferred Stock (par value)  B. Common Stock (par value)  C. Paid In Capital in Excess of Parr (Additional Paid in Capital)  XXVIII.Treasury Stock: A. Stock that has been issued and then subsequently repurchased by the corporation with the  intent to reissue those shares at a later date. B. Treasury stock is stock that has been issued but is not outstanding. C. Treasury stock is a contra-equity account with a normal debit balance. D. Why would a company repurchase its own stock? 1. Use the shares for another purpose a) Acquire control of another corporation b) Employee stock options  2. To maintain a strong market for its stock or show that management has confidence in  the current price (and may deserve to trade at a higher price).  9Monday, January 30, 2017 E. Entries (Cost Method):  F. Look at the Stockholders’ Equity section of the Balance Sheet 1. Treasury stock is subtracted at the bottom of the statement, after Retained Earnings. 2. None of the treasury stock entries affect the Common Stock account. 3. Note the number of outstanding shares, 400. XXIX.Book Value Per Share: Net Purchases = Purchases - Discounts - Returns + Freight In  A. A Balance Sheet Calculation  B. If we were to liquidate the corporation at its book value, how much would each share of  common stock receive? C. Note on Prefer Stock Dividends: If preferred stock is non-cumulative, dividends in  arrears are 0.  XXX.Look at the Income Statement  XXXI.No More EXTRAORDINARY ITEMS!!!! (Items that are unusual and infrequent are  classified as other revenues and expenses.)  XXXII.DISCONTINUED OPERATIONS – A component of an entity comprises operations and  cash flows that can be clearly distinguished, operationally and for financial reporting  purposes, from the rest of the entity.  A. Class Example: Pink Co, has a Reason Division. On October 15, the division is sold for  $92,500. The division had a carrying value of $62,500. In addition, the division had an  operating loss for the year of $22,500. B. Income or Loss From Operations C. Gain or Loss on Disposal of Segment D. Look at the Multiple Step Income Statement [Chapter 11 Notes (10)] E. Discontinued Operations are shown Net of Tax!  XXXIII.Earnings Per Share (EPS)  A. An Income Statement calculation  B. If we were to distribute a dividend equal to net income, how much would each share of  common stock receive?  C. Earnings Per Share (EPS) = (Net Income - Preferred Dividends) / (Weighted Average  Number of Common Shares Outstanding) D. Preferred Dividends  10Monday, January 30, 2017 1. If cumulative preferred stock, the annual dividend requirement for the current year is  deducted, whether or not it is declared.  2. Dividends in arrears from prior years are irrelevant in this computation.  3. If non-cumulative, only the dividend declared for preferred stock is deducted.  E. Class Problem [Chapter 11 Notes (11)]  F. Weighted Average Computation: Multiply by time left in year as fraction over 12  G. EPS Computation = (Net Income - Preferred Dividend) / Weighted Average Shares  Outstanding  XXXIV.Price Earnings (P/E) Ratio: “The Multiple” = Market Price / Earnings Per Share  XXXV.Market Capitalization  XXXVI.Dividends- Earnings distributed to stockholders  A. Dividend Dates  1. Date of Declaration  2. Date of Record  3. Date of Distribution  4. Dividends are not an expense.  5. Dividend Yield = Annual Dividend / Market Price  B. Usually, dividends come out of Retained Earnings. 1. Net income that has accumulated in the corporation. 2. Dividends, when declared, reduce retained earnings.  C. Cash Dividends  1. On Date of Declaration, the corporation declares a dividend of $100k.  2. On Date of Record, anyone that owns the stock has the right to the dividend.  3. On Date of Distribution, the corporation pays the dividend.  4. Usually, you must have cash available and retained earnings to declare and pay a cash  dividend.  5. A corporation does not pay cash dividends to treasury stock.  6. Preferred dividends in arrears (Not a Liability). 7. A dividend becomes a liability only when declared. 11Monday, January 30, 2017 D. Stock Dividends  1. Total par value immediately before the split = total par value immediately after the  split. 2. Large Stock Dividend (>20%-25%)—a stock split effected in the form of a dividend XXXVII.Statement Of (Changes In) Retained Earnings  A. Statement of Retained Earnings [Chapter 11 Notes (14)]  1. Beginning Retained Earnings  2. +/- Prior Period Adjustment (shown net of tax)  3. = Adjusted Beginning Retained Earnings  4. + Net Income  5. - Dividends Declared  6. =Ending Retained Earnings  B. Prior Period Adjustments  1. A Correction of an Error  a) Mathematical Error  b) GAAP Error  c) Shown Net of Tax  2. If the error occurs in a year that is presented, present corrected financial statement(s). 3. If the error occurs in a prior year to those presented, adjust beginning Retained  Earnings of the earliest period presented, shown net of tax. XXXVIII.Change in Accounting Estimate  A. Examples  1. Bad Debts  2. Warranties  3. Useful Life  4. Salvage Value  B. Accounting- Current and Prospective Approach  C. Your instructor says, “Accounting estimates are not errors.”  12Monday, January 30, 2017 XXXIX.Change in Accounting Principle  A. Requires retrospective application. B. Means applying a different accounting principle to prior periods as if that principle had  always been used. C. Prior statements are actually restated. D. The effect on net income for years before those presented will be presented as an  adjustment to beginning retained earnings, shown net of tax. E. Exception…  1. The exception is when you do not have the ability to recalculate using the new  method...perhaps in changing from FIFO to LIFO.  2. If this is the case, account for this change as you would a change in accounting  estimate...just go on your merry way.  F. Changes in method of depreciation, depletion, and amortization methods are treated as  changes in estimate. 1. We do not go back and do any retrospective application.  2. Those changes only affect current and prospective periods.  3. Just go on your merry way! XL.EBIT- Earnings Before Interest and Tax A. Discounts the choice of financing  B. Discounts the effect of taxes  C. Popular substitute for operating income XLI.EBITDA- Earnings Before Interest and Tax and Depreciation and Amortization A. Discounts non-cash expenses  B. Popular substitute for statement of cash flows operating activity section XLII.EBITDAR- Earnings Before Interest and Tax and Depreciation and Amortization and Rent  Chapter 10  Bonds: Giant Note Payables that can be bought/sold, Bonds = Debt, Stock = Equity  I. Characteristics  A. Secured: The debt is guaranteed by specific assets. 13Monday, January 30, 2017 B. Debenture: A bond that is unsecured. It is issued on the credit rating of the corporation.  C. Coupon (Bearer): Coupons are attached at the bottom of the bond. Every six months, the  owner detaches the coupon, and deposits it with their bank to receive interest.  D. Registered: The issuer of the bond keeps track of everyone that owns the bond. At the  interest dates, the issuer will send out the interest directly to the bondholder.  E. Term: The entire bond issue matures on the same date.  F. Serial: The bond maturity dates are staggered over several years.  G. Callable: At the option of the corporation, the bonds can be retired at a fixed price, before  maturity.  H. Convertible: At the option of the bondholder, the bonds can be converted into common  stock.  I. Zero-Coupon Bonds (e.g., savings bonds): A bond in which all the interest accumulates  and is paid at maturity.  J. Junk Bonds: High return, high risk debt investments.  K. Advantages  1. Bonds do not affect stockholder control.  2. Interest on bonds is tax deductible.  3. Bonds can increase return on equity. L. Disadvantages  1. Bonds require payment of both periodic interest (usually semi-annual payments), and  par value (face value) at maturity.  2. Bonds can decrease return on equity when the company pays more in interest than it  earns on the borrowed funds. II. Entries- Theme  A. On Dec 31, 20X0, we issue $30,000 of 6% bonds.  B. Interest payment dates, 6/30, 12/31, 30 year bonds.  1. This is called semi-annual interest.  2. Calculation of interest: Interest = Principle x Rate x Time  a) Interest = (30,000) x 6% x 6/12 = 9,000 III. Variation 1: Bonds Issued Between (same as before) Interest Dates (Appendix 14C): 14Monday, January 30, 2017 A. On Mar 1, 20X1, we issue $300,000, 6% bonds. Bonds are dated, 12/31/x0, Interest  dates, 6/30, 12/31.  B. When bonds are issued between interest dates, the cash received is the selling price of the  bonds + accrued interest since the last interest date. IV. Variation 2: Discount (Market % > Bond %)  A. Issue $300,000 bonds, 6%, 10 years.  B. Let’s say that the market rate is greater than the bond rate, and these bonds are issued @  98 (% of face value). C. Use the straight-line method to amortize the discount, interest paid on Jun 30, Dec 31. D. Balance Sheet Presentation V. Variation 3:  A. Issue $800,000 bonds, 5%, 20 years  B. Let’s say that the market rate is smaller than the bond rate, and these bonds are issued @  103 (%).  C. Use the straight-line method to amortize the premium, interest paid on Jun 30, Dec 31. VI. Stock (1) vs. Bond Issuances (2) [Check Chart]  A. Substance  1. Equity  2. Debt  B. Ownership  1. Yes, Owner  2. No, Creditor  C. Cash Paid Out- Lump Sum (Single Payment)  1. N/A  2. Principal  D. Cash Paid Out- Annuity  1. Dividends  2. Interest  E. Deductible (Is it an expense?)  15Monday, January 30, 2017 1. No  2. Yes  F. Carrying Value of a Bond = Face Value [Unamortized (+ Premium or - Discount)]  VII.Variation 4: Comprehensive Problem (Premium and In Between Interest Dates)  A. Carrying value of a bond = Face Value {+ Premium / - Discount} B. Time-line of a Bond: C. If we have a 7 year bond, which is dated Dec 31, 20X0, but is issued 5/1 20X1, how  many months will the bond be outstanding? = 80 months  D. The discount or premium is amortized over the period the bonds are outstanding. E. Problem: $200,000 bonds, 7 years, 6%, issued, @ 104 on 5/1/x1. Int Pay’s: 6,000 June  30, 6,000 December 31. Bonds are dated, Dec 31, 20X0. VIII.Early Retirement  A. Selling and Asset  1. Depreciate the asset up to date  2. Close out the asset and related accumulated depreciation accounts  3. Record gain or loss, if appropriate. B. Early Retirement of Debt 1. Amortize discount/premium up to date (you must also pay interest to date, but in  most problems, we will assume that this has already been done).  2. Close out the bonds payable account and the discount/premium account.  3. Record gain or loss, if appropriate. C. Class Problem- Continuation of Previous Problem  1. On 11/1/X4, all of the bonds are retired @ 102.  2. Entry (assume premium/discount has been amortized to date, and interest has been  paid to date): D. All gains and losses on early extinguishment of debt go on the income statement as other  gains and losses, unless they are truly unusual and infrequent and then they go on the  income statement as extraordinary items and are shown net of tax. IX. Conversion of Bonds  A. Similar to retirement  16Monday, January 30, 2017 B. No cash paid, instead stock issued  C. No gain or loss recorded  D. Class Problem: X. Pricing a Bond (Appendix 14A)  A. The Concept of Present Value  1. Lump Sum—a single payment  2. Annuity—an equal stream of payments B. Bond Commitments  1. Principal  2. Investment  C. Present Value Tables—Tables B1 and B3 in the back of our textbook (pages B-10, 11).  1. i = interest rate per period (use half of the annual market rate for present value  calculations).  a) Always use the market rate (the effective rate or the effective yield) for  computing the selling price (present value) of bonds  b) This is an example of substance over form: When the economic substance of a  transaction differs from the legal form, accountants tend to emphasize the  economic substance.  2. n = number of periods (double the number of years).  3. Use the bond rate to calculate the amount of the interest payment. D. Class Example:  1. $100,000 of bonds, 10 years, interest: June 30 and December 31  2. Bond rate, 10%; Market Rate 12%  3. Computations:  a) (Lump Sum) Principal = 100,000 x .312 (Present Value of 1, i=6, n =20) = 31,200  b) (Annuity) Interest = 5,000 (100,000 x 10% x 6/12) x 11.470 (Present Value of  Annuity, i=6, n=20) = 57,350  c) Total = 88,550 = Worth of Future Payments Today  4. Journal Entry (issuance of bond):  17Monday, January 30, 2017 XI. Effective Interest Method of Amortization  A. Straight-Line Method: A constant amount of interest expense every six months.  B. Effective Interest Method: A constant rate of interest expense every six months (another  example of substance over form).  1. Interest Expense = Carrying Value of the Bonds x Market % x 1⁄2  2. Cash = Face Value x Bond Rate x 1⁄2  3. Difference = Amount of Discount/Premium Amortization  C. Class Problem—Use previous example. 18

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