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Financial Accounting Chapter 12 Notes

by: bauer47 Notetaker

Financial Accounting Chapter 12 Notes ACC-142

Marketplace > Iowa Central Community College > Accounting > ACC-142 > Financial Accounting Chapter 12 Notes
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These notes cover types of bonds and how to account for them. There is an excel spreadsheet that accompanies these notes.
Financial Accounting
DawnA. Humburg
Class Notes
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This 7 page Class Notes was uploaded by bauer47 Notetaker on Wednesday March 2, 2016. The Class Notes belongs to ACC-142 at Iowa Central Community College taught by DawnA. Humburg in Fall 2015. Since its upload, it has received 31 views. For similar materials see Financial Accounting in Accounting at Iowa Central Community College.


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Date Created: 03/02/16
Chapter 12 Outline Name ________________ Please make a good faith effort to complete this for Tuesday’s class (12/1/15).  THIS  ASSIGNMENT IS WORTH 30 POINTS.  PLEASE HAVE THIS PRINTED FOR  12/1/15.  LTL 1) Accounting for LTN/P and M/P: a. These two accounts are classified as LTL (one year from the BS date) b. How are these different from A/P? time, interest, promissory note c. What is normally incurred for these two payables? Interest expense d. What is the formula for simple interest? PXRXT/12 (months) or 360 for (days) e. What is an amortization schedule? Details all the principal and interest payments i. Refer to the excel workbook file named “Ch. 12”, worksheet named  “mort. Int. amor. schedule” f. Most LTL are paid in installments (monthly). 2) Bonds payable > LTL that are sold by corporations, companies, or the  government, or governmental entities (IA Central) to raise cash or capital; the main two ways that corporations raise capital or equity are: selling bonds  (LTL) or selling stock (SHE) a. Bond characteristics: i. Bonds usually are issued (sold) with what amount printed on  them? Face value (principal); what is this amount called? principal or maturity value ii. Bonds usually pay interest (cash) to the bondholders every six  months; to the bondholder it is interest revenue, to us it is interest  expense iii. The rate that bonds offer to their buyers is called the stated  interest rate or coupon rate or nominal rate or face rate (this is  fixed according to the bond indenture or contract). iv. The amount that the borrower (the corporation) must pay back to  the bondholders is called the face value or principal or maturity  value or par value. v. When are bonds due? On the maturity date (usually a period of  years) vi. The return on the bondholders’ investment is called interest  revenue; what is the formula to calculate this per period (six  month)? P X R (stated interest rate) X 6/12 b. Types of bonds: i. This type of bonds is backed up by pledged assets: secured  (collateralized or pledged) ii. This type of bonds matures on one date:  term__________________ iii. This type of bonds matures at intervals of time:  serial______________ iv. This type of bonds is not backed up by pledged assets: debenture c. Bond prices: i. Bonds may be issued (sold) in the following ways: ii. Scenario: we sold $100,000 of bonds, 6% interest 1. At face value > this means we received $100,000 when the  bonds were sold a. Other ways to indicate selling at face value: i. market value (selling price) = face value ii. Selling at 100 which means selling at 100% of  face value 2. At a discount > this means we received below face value a. Other ways to indicate selling at a discount: i. market value ($4) is lower than face value ($5) ii. Selling at 98 which means selling at 98% of face value 3. At a premium > this means we received more than face  value a. Other ways to indicate selling at a premium: i. market value ($5) greater than face value ($4) ii. Selling at 102 which means selling at 102% of  face value d. Present value > this indicates the dollar amount we will receive when  we sell bonds; sum of the PV of the bonds (face value) plus the PV of  the interest payments e. The two main ways to raise capital for a corporation are: i. bonds 1. This way will cost the issuing corporation interest payments  every six months   ii. stocks 1. This way may or may not cost the issuing corporation  dividend payments (this depends on the board of directors) iii. How do we increase the earnings per share of our stock? Issue  bonds, repurchase our own stock (treasury stock) 3) Journal entries for bonds: a. Scenario: sold $250,000 (face value) of 4% (stated), 10­year bonds  (term) on January 1, 2015 (selling date) i. At face value: Jan. 1 Cash 250,000 Bonds Pay. (+LTL) (=face) 250,000 (record issuance of bonds) Jun. 30 Interest Expense *5,000 Cash *5,000 (record semiannual interest; *$250,000 X .04 X 6/12) (once we calculate the interest paid to bondholders, it will  remain the same over the life of the bonds; set by contract) Dec. 31 Interest Expense *5,000 Cash *5,000 (record semiannual interest) What is the carrying value of the bonds as of December 31?  Face value ­ unamortized discount OR + unamortized premium;  $250,000 (this will be the same until the maturity date) ii. At a premium: sold bonds at 101 (using the straight line method) Jan. 1 Cash ($250,000 X 1.01) 252,500 Bonds Pay. (+LTL,=face) 250,000 Prem. On Bds. Pay. (+LTL)*     2,500  (record issuance of bonds at 101) *plug figure; may also be calculated as $250,000 X . 01 Jun. 30 Interest Expense  4,875 (plug) Prem. On Bd. Pay.*    125 Cash **5,000 (record first semiannual interest payment and  amortize (write off) the premium) *this account is classified as a LTL; Calculated as $2,500/20 semiannual interest  periods (10 year term bonds)= $125 **same as above when selling at face value: $250,000 X 4% X 6/12 = 5,000 Dec. 31 Interest Ex.*                  4,875 Prem. On Bds. Pay.** 125 Cash *** 5,000 *plug figure and same as Jun. 30 entry **same as Jun. 30 entry ***same as credit to Cash for every six month  period (record interest payment and amortization of  premium)  What is the carrying value of the bonds after the Dec. 31 entry? Face value – unamortized discount + unamortized premium; $250,000 + (2,500 – 125 from June 30 – 125 from Dec. 31) =  $250,000 + 2,250 = $252,250; beginning carrying value was  $252,500 or $252,500 – 250 = $252,250* for every six month  period the carrying value will decrease until it reaches $250,000  (face value) On the BS: LTL: Bonds Payable $250,000 Prem. On Bd. Pay.       2,250 $252,250* iii. Selling at a discount: sold bonds at 99 (using the straight line  method); $250,000 face value; 10 year bonds, 4% stated rate Jan. 1 Cash ($250,000 X 99%) 247,500 Disc. On Bds. Pay.*(+xLTL)      2,500 Bonds Pay. (=face) 250,000 (record issuance at a discount) *classified as a contra LTL account; plug figure Jun. 30 Interest Expense *   5,125 Disc. Bds. Pay.*    125 Cash *** 5,000 (record first semiannual interest payment) *plug figure **calculated as $2,500/20 number of semiannual  interest periods ***same as credit to cash for prior transactions Dec. 31 Interest Expense *(same as June 30) ______________** Cash *** (record first semiannual interest payment) *plug figure **calculated as $_________/_____ number of  semiannual interest periods ***same as credit to cash for prior transactions What is the carrying value of the bonds after the Dec.  31 entry? $250,000 – (2500 – (125 + 125)) = $250,000 – 2,250 = $247,750 OR $247,500 + (125 + 125) =  $247,750 ending carrying value 4) Retirement of bonds: a. Scenario: called in bonds, $200,000 face value, b. JE at maturity (due date): Bonds Pay. (=face) 200,000 Cash  200,000 c. JE before maturity; called in bonds at 101 when the carrying value was  $195,000 (face value + unamortized premium OR – unamortized  discount); $200,000 – 5,000 discount = 195,000 carrying value; its early or before the end of the term because the carrying value is not equal to  face value Bonds Pay. (=face)(1) 200,000 Disc. On Bds. Pay.* (2)     5,000 Gain on Redemption** (4) 3,000 Cash (200,000 X 1.01%) (3) 202,000 *classified as a(n) contra LTL; plug figure *calculated as $200,000 (face) – 195,000 (carrying value) ** plug figure What type of bonds are these if we can redeem them before their  maturity date? Callable bonds; why would a corporation or  governmental entity do this? To save major interest expense; how  often is interest paid? Six months 5) Debt to equity ratio > used to show _proportion of liabilities to debt;  measures financial leverage; formula is total liab./total equity; what  number would we like this to be below? 1; if debt is more than equity, this  is called a deficit 6) Appendix 12A: time value of money i. This is an alternative way to calculate the cash proceeds of  bonds upon issuance; 101, MV is < FV ii. It is the sum of the PV of the face value (FV) plus the Present  Value of the interest payments (also referred to as a(n) annuity) iii. In order to calculate the PV of the bond issuance, we need to  know 3 variables: iv. Principal (p) > also called the face value v. # of periods (n) > indicates the number of interest periods; 10  year bonds = 20 periods (semiannual)  vi. interest rate (i)> indicates the market rate at the time the bonds  are sold b. Which type of interest is it? i. This type calculates interest upon interest: compound ii. This type is easy to calculate: simple interest; to calculate the  interest payments on bonds; face value x stated rate x 6/12 iii. Which type yields the most interest? Compound interest c. Present value calculations: (use appendix b) i. Scenario: sold bonds, 7% interest rate (stated rate), Face value of $100,000, when the market rate was 6%, 10 year bonds 1. Identify the variables: a. p = 100,000 (face value) b. n = 20 (10 X 2) c. ‘i= 3% (6%/2) (semiannual) 2. PV of the principal (lump sum) and interest (annuity); table  b­1 and table b­2 $100,000 X .554 (factor from table b­1) = 55,400 + $3,500 ($100,000 X .035) X 14.878 (factor from table b­2) =  52,073; $3500 x 20 = $70,000 (every interest payment) +  100,000 FV = $170,000 (future value) total we would  have to pay Total Present value of $107,473* (55,400 + 52,073) *interpret this number: this number represents the cash  proceeds of this bond issue, they will be sold at a  premium of $7,473  7) Effective­interest method of amortizing premium or discount (an alternative to using the straight line method which yields the same dollar amounts  every six months) a. Scenario: first, we need to calculate the selling price; assume we sold  $100,000 FV, 5­year bonds, 5% interest rate, when the market interest  rate was 4% on January 1, 2015 JE: Jan. 1Cash* 109375 Bonds Payable 100,000 Prem. Bds. Pay.     9,375 What is the carrying value? $100,000 (fv) + 9,375 (plug) = $109,375  = cash proceeds *Present value of bond issue: (p = 100,000, n = 10, ‘i=2%) $100,000 X .820 (B­1) = $82,000 + $2,500 X 10.95 (B­2) = $27,375 Total present value = $109,375;  Now open the Excel file “Ch. 12”, worksheet named “eff. ‘int. amor. schedule” and complete the schedule.


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