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# Accounting, future value, present value 12.1 BUS 20

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Chapt. 12.1 Sunday, April 19, 2015 4:59 PM TIME VALUE OF MONEYC : ash received today has earnings potential that changes its future value. Future Value = Present Valuex (1 + Interest Rate), so Future Value = $10 x (1 + 2%) = $10 x (1.02) = $10.20 YEAR 2)Future Value =$ 10.20 x (1 + .02) = $10.404 If you think about thetwo years combined, the mathematical formula is… Future Value = Present Valuex (1 + Interest Rate) x (1 + Interest Rate) ORFuture Value = Present Valuex (1 + Interest Rate)2^ EX) If I received $10 today, how much would I have at the end of ten years if I invest the money at 2% compounded annually? PRESENT VALUE Ex) What if I wanted to know how much money to put away NOW in order to have $50 at the end of 10 years assuming my money can be invested at 2%? $50=Future value Present Value = $50 x [1 / (1+.02)^10] Chapt. 12.1 Sunday, April 19, 2015 4:59 PM TIME VALUE OF MONEYC : ash received today has earnings potential that changes its future value. Future Value = Present Valuex (1 + Interest Rate), so Future Value = $10 x (1 + 2%) = $10 x (1.02) = $10.20 YEAR 2)Future Value =$ 10.20 x (1 + .02) = $10.404 If you think about thetwo years combined, the mathematical formula is… Future Value = Present Valuex (1 + Interest Rate) x (1 + Interest Rate) ORFuture Value = Present Valuex (1 + Interest Rate)2^ EX) If I received $10 today, how much would I have at the end of ten years if I invest the money at 2% compounded annually? PRESENT VALUE Ex) What if I wanted to know how much money to put away NOW in order to have $50 at the end of 10 years assuming my money can be invested at 2%? $50=Future value Present Value = $50 x [1 / (1+.02)^10] Ex) What if I wanted to know how much money to put away NOW in order to have $50 at the end of 10 years assuming my money can be invested at 2%? $50=Future value Present Value = $50 x [1 / (1+.02)^10] = $50 x [1/1.21899442] = $50 x .8203483 = $41.0174 $41=Present value =$50 $9= Interest Discounting EX )If I want to have $50 at the end of 10 years and I can invest my money at 2%, how much would I have to invest? Present Value = Future Value x Factor from Present Value of $1 Table Ex) What if I wanted to know how much money to put away NOW in order to have $50 at the end of 10 years assuming my money can be invested at 2%? $50=Future value Present Value = $50 x [1 / (1+.02)^10] = $50 x [1/1.21899442] = $50 x .8203483 = $41.0174 $41=Present value =$50 $9= Interest Discounting EX )If I want to have $50 at the end of 10 years and I can invest my money at 2%, how much would I have to invest? Present Value = Future Value x Factor from Present Value of $1 Table Present Value = $50 x.82035 =$41.0175 EX) On a savings account, if the interest rate 6%and the money will be accumulated for 10 years, but the bank compounds interest quarterly, then theinterest rate per quarteris 4% (16% per year / 4 quarters per year) and the time periods are40 quarters (10 years x 4 quarters per year). The 4% quarterly rate and the 4q 0uarterswould be used to look up the appropriate factor from the present value table. ANNUITY:Equal cash payments made over regular time intervals. EX) If I want to withdraw $50 at the end of each year for the next 10 years and the interest rate is 2%, what amount of money would I have to invest right now? • Present Value = Future Value x Factor from Present Value of $1 Table • Use….Present value $1 chart Use ALL the 2%!!!! Present Value = $50 x.82035 =$41.0175 EX) On a savings account, if the interest rate 6%and the money will be accumulated for 10 years, but the bank compounds interest quarterly, then theinterest rate per quarteris 4% (16% per year / 4 quarters per year) and the time periods are40 quarters (10 years x 4 quarters per year). The 4% quarterly rate and the 4q 0uarterswould be used to look up the appropriate factor from the present value table. ANNUITY:Equal cash payments made over regular time intervals. EX) If I want to withdraw $50 at the end of each year for the next 10 years and the interest rate is 2%, what amount of money would I have to invest right now? • Present Value = Future Value x Factor from Present Value of $1 Table • Use….Present value $1 chart Use ALL the 2%!!!! • We would need to invest $449.13 right now in order to take out $50 each year for the next 10 years assuming money can be invested at 2%. OR Anotherway in computingis… • We could add the 10 factors together first and then do one multiplication: ----------------------------------------------------------------------------------------------------------------------------- • We would need to invest $449.13 right now in order to take out $50 each year for the next 10 years assuming money can be invested at 2%. OR Anotherway in computingis… • We could add the 10 factors together first and then do one multiplication: ----------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------- EX) if I want to withdraw $50 every year for the next 10 years and the interest rate is 10%, what amount of money would I have to invest right now? • Interest rate = 2% • Time periods =10 We can again quickly solve the problem with a simple multiplication: • Present Value= $50 x 8.98259 =$449.1295 CHAPTER 15: LONG-TERM LIABILITIES ----------------------------------------------------------------------------------------------------------------------------- EX) if I want to withdraw $50 every year for the next 10 years and the interest rate is 10%, what amount of money would I have to invest right now? • Interest rate = 2% • Time periods =10 We can again quickly solve the problem with a simple multiplication: • Present Value= $50 x 8.98259 =$449.1295 CHAPTER 15: LONG-TERM LIABILITIES We can again quickly solve the problem with a simple multiplication: • Present Value= $50 x 8.98259 =$449.1295 CHAPTER 15: LONG-TERM LIABILITIES EXAMPLE 1--BONDS PAYABLE ISSUED AT A DISCOUNT A $100,000, three-year, 12% bond, which pays interest on June 30 and December 31 is issued on December 31, 2012, when thm e arket rate of interest is 16The bond is dated December 31, 2012. The financial reporting date of the issuing corporation is December 31. • Bondcontract-- 3 years • Compounding period-- every six months or twice each year ○ We are told that the bond is going to pay interest twice each year. We're also told that the market rate of interest is 16% per yThis "market" rate of interest is the rate of interest that other similar investments available to investors are currently paying. • The date of the bond is December 31, 2012. ○ This is the date on which we expect to issue the bonds and receive our cash from the creditors/bondholders. • Given that the term is 3 years, wealso know whenthe bond matures--3 years from December 31, 2012 or on December 31, 2015. Term in years (n): 3 Market rate of interest(r): 16% Number of MarketTimesInterestisPaidper year (m) : 2 • The face (or par) valueis a cash payment that the borrower /bond issuer is promising to pay thelender/bondinvestoronthe maturity date of the bond, December 31, 2015. • Face value = $100,000. • The stated rate of interestspecifies cash paymentsas a percentage of the face value that the borrower/bond issuer is promising to pay the lender/bond investor astpecified intervals over the life of the bond. • The stated rate of interestfor this bond is 12%of face value per year or $12,000 • ($100,000 face value x 12%) ; ○ HOWEVER the specified payment interval is twice each year, so the dollar amount of each periodic stated interest payment is going to be $6,000 ($12,000 / 2). <--- CORRECT ANSWER • Periodic future value amount is $6,000. • So bonds involve the promise to make TWO specific future cash payments to the lenders: one payment on the maturity date and aseries of annuity payments at regular intervals over the bond term. • $100,000 on December 31, 2015 and $6,000 every 6 months for the next 3 years beginning on June 30, 2013: We can again quickly solve the problem with a simple multiplication: • Present Value= $50 x 8.98259 =$449.1295 CHAPTER 15: LONG-TERM LIABILITIES EXAMPLE 1--BONDS PAYABLE ISSUED AT A DISCOUNT A $100,000, three-year, 12% bond, which pays interest on June 30 and December 31 is issued on December 31, 2012, when thm e arket rate of interest is 16The bond is dated December 31, 2012. The financial reporting date of the issuing corporation is December 31. • Bondcontract-- 3 years • Compounding period-- every six months or twice each year ○ We are told that the bond is going to pay interest twice each year. We're also told that the market rate of interest is 16% per yThis "market" rate of interest is the rate of interest that other similar investments available to investors are currently paying. • The date of the bond is December 31, 2012. ○ This is the date on which we expect to issue the bonds and receive our cash from the creditors/bondholders. • Given that the term is 3 years, wealso know whenthe bond matures--3 years from December 31, 2012 or on December 31, 2015. Term in years (n): 3 Market rate of interest(r): 16% Number of MarketTimesInterestisPaidper year (m) : 2 • The face (or par) valueis a cash payment that the borrower /bond issuer is promising to pay thelender/bondinvestoronthe maturity date of the bond, December 31, 2015. • Face value = $100,000. • The stated rate of interestspecifies cash paymentsas a percentage of the face value that the borrower/bond issuer is promising to pay the lender/bond investor astpecified intervals over the life of the bond. • The stated rate of interestfor this bond is 12%of face value per year or $12,000 • ($100,000 face value x 12%) ; ○ HOWEVER the specified payment interval is twice each year, so the dollar amount of each periodic stated interest payment is going to be $6,000 ($12,000 / 2). <--- CORRECT ANSWER • Periodic future value amount is $6,000. • So bonds involve the promise to make TWO specific future cash payments to the lenders: one payment on the maturity date and aseries of annuity payments at regular intervals over the bond term. • $100,000 on December 31, 2015 and $6,000 every 6 months for the next 3 years beginning on June 30, 2013: • So bonds involve the promise to make TWO specific future cash payments to the lenders: one payment on the maturity date and aseries of annuity payments at regular intervals over the bond term. • $100,000 on December 31, 2015 and $6,000 every 6 months for the next 3 years beginning on June 30, 2013: • The$100,000 face value payment is made one time on the maturity date. The computation of thepresent value of a single amountis: • The $6,000 stated interest payment is an annuity payment. The computation of the present value of an annuityis: *Remember, our compounding period is every six months or twice each year. * The appropriate rate to use market rate ( se-ainnual basis) (16% / 8%= • So the present valueof the face amount would be computed as follows: Present Value= $100,000 x 0.63017 =$63,017 Presentvalue ofan ordinary annuity of$1table • So bonds involve the promise to make TWO specific future cash payments to the lenders: one payment on the maturity date and aseries of annuity payments at regular intervals over the bond term. • $100,000 on December 31, 2015 and $6,000 every 6 months for the next 3 years beginning on June 30, 2013: • The$100,000 face value payment is made one time on the maturity date. The computation of thepresent value of a single amountis: • The $6,000 stated interest payment is an annuity payment. The computation of the present value of an annuityis: *Remember, our compounding period is every six months or twice each year. * The appropriate rate to use market rate ( se-ainnual basis) (16% / 8%= • So the present valueof the face amount would be computed as follows: Present Value= $100,000 x 0.63017 =$63,017 Presentvalue ofan ordinary annuity of$1table • So the present value of the stated interest payments would be computed as follows: Present Value= $6,000 x 4.62288 = $27,737.28 rounded to $27,737 TheTOTAL present value of both future cash paymen is$63,017 + 27,737 = ▯▯▯▯▯▯▯ Remember, the future cash payments must dotwo things: 1) pay back the borrowing 2) pay the interest. • The bond issuer is promising to make one payment of $100,000 &&&& 6 payments of $6,000 each. ○ so the bond issuer is promising to make future cash payments totaling $136,000. (100,000+ 6,000 x6). • ▯▯▯▯▯▯▯ of this total must go towards paying back the borrowing --the remainder ▯▯▯▯▯▯▯ ($136,000 -$90,754) =INTEREST. • • So the present value of the stated interest payments would be computed as follows: Present Value= $6,000 x 4.62288 = $27,737.28 rounded to $27,737 TheTOTAL present value of both future cash paymen is$63,017 + 27,737 = ▯▯▯▯▯▯▯ Remember, the future cash payments must dotwo things: 1) pay back the borrowing 2) pay the interest. • The bond issuer is promising to make one payment of $100,000 &&&& 6 payments of $6,000 each. ○ so the bond issuer is promising to make future cash payments totaling $136,000. (100,000+ 6,000 x6). • ▯▯▯▯▯▯▯ of this total must go towards paying back the borrowing --the remainder ▯▯▯▯▯▯▯ ($136,000 -$90,754) =INTEREST. • Discount • The face value payment pays back the ▯ ▯▯▯▯▯▯ of borrowing. • The other $9,246 of the face value payment is ain terest payment. (100,000 -90,754)=9,246 Face value Bond price Bond Discount: Portion of the face payment that is an interest payment. BONDPROBLEM Discount • The face value payment pays back the ▯ ▯▯▯▯▯▯ of borrowing. • The other $9,246 of the face value payment is ain terest payment. (100,000 -90,754)=9,246 Face value Bond price Bond Discount: Portion of the face payment that is an interest payment. BONDPROBLEM CHAPTER 15: LONG-TERM LIABILITIES EXAMPLE 2 --BONDS PAYABLE ISSUED AT A PREMIUM A $100,000, three-year, 12% bond, which pays interest on June 30 and December 31 is issued on December 31, 2012, when the market rate of interest is 8%. The bond is dated December 31, 2012. The financial reporting date of the issuing corporation is December 31. We have now identified the two future cash values promised under the bond contract: 1. a $100,000 payment to be made on the maturity date &&& 2. a $6,000 annuity to be paid sem-iannually over the next three years. These future values must bed iscounted. CHAPTER 15: LONG-TERM LIABILITIES EXAMPLE 2 --BONDS PAYABLE ISSUED AT A PREMIUM A $100,000, three-year, 12% bond, which pays interest on June 30 and December 31 is issued on December 31, 2012, when the market rate of interest is 8%. The bond is dated December 31, 2012. The financial reporting date of the issuing corporation is December 31. We have now identified the two future cash values promised under the bond contract: 1. a $100,000 payment to be made on the maturity date &&& 2. a $6,000 annuity to be paid sem-iannually over the next three years. These future values must bed iscounted. • Remember, our compounding period ise very six months or twice each year. • This is a 3 year bond, so there would e semi-annual time periods. • Remember, the bond investors are trying to choose from an array of similar investments which are currently paying % per year . • market rate--don't forget, though, that it needs to be put on a semi -annual basis, too--4% (8% / 2). The TOTAL present value of both future cash paymen it s$79,031 + 31,453$ 110,484 • Remember, our compounding period ise very six months or twice each year. • This is a 3 year bond, so there would e semi-annual time periods. • Remember, the bond investors are trying to choose from an array of similar investments which are currently paying % per year . • market rate--don't forget, though, that it needs to be put on a semi -annual basis, too--4% (8% / 2). The TOTAL present value of both future cash paymen it s$79,031 + 31,453$ 110,484 The TOTAL present value of both future cash paymen it s$79,031 + 31,453$ 110,484 • The bond issuer is promising to make one payment of $100,000 and 6 payments of $6,000 each. • So the bond issuer is promising to make future cash payments totaling $136,000. • $110,484 of this total must go towards paying back the borrowing. • Remainder of $25,516 ($136,000 less $110,484) is interest. We borrowed $110,484. On the maturity we will make the face value payment of $100,000. We still have $10,484 of borrowing to pay back. Notice that the bond price was greater than the face value. Bond premiumis additional borrowing (above the face value) that is paid back by the stated interest payments. In the end, we will return the exact same rate as the market --8%. If the market rate > stated ra, then the bond will be issued at a discount. If the market rate < stated ra, then the bond will be issued at a premium. The TOTAL present value of both future cash paymen it s$79,031 + 31,453$ 110,484 • The bond issuer is promising to make one payment of $100,000 and 6 payments of $6,000 each. • So the bond issuer is promising to make future cash payments totaling $136,000. • $110,484 of this total must go towards paying back the borrowing. • Remainder of $25,516 ($136,000 less $110,484) is interest. We borrowed $110,484. On the maturity we will make the face value payment of $100,000. We still have $10,484 of borrowing to pay back. Notice that the bond price was greater than the face value. Bond premiumis additional borrowing (above the face value) that is paid back by the stated interest payments. In the end, we will return the exact same rate as the market --8%. If the market rate > stated ra, then the bond will be issued at a discount. If the market rate < stated ra, then the bond will be issued at a premium. Homework Sunday, April 26, 2015 1:41 PM ----------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------------- Outline Sunday, April 26, 2015 2:35 PM Long-term liabilities should be presented on the balance sheet at thediscounted present value of the future cash payments. Future cash payments: All of these payments we promise to make to the lender Future Value = Present Value x (1 + Rate) $10.50 = $10 x (1.05) 1+5%] [ and n = # of time periods Future Value x 1/(1 + Rate) = Present Value So $10 x 1/(1.05) = $10 x .95238 = $9.5238 Future Value x 1/(1 + Rate)^n = Present Value So $12 x 1/(1.05)^4 = $12 x 1/1.21550 = $12 x .82270 = $9.8724 If I give you the choice of taking $35 now OR $10 at the end of every year for the next four years and money can be invested to earn a 5% rate of return, which would you rather take? Year 1:$10 x .95238 = $9.5238 (where .95238 is the PV Factor for 5%, 1 period) Year 2:$10 x .90703 = 9.0703 (where .90703 is the PV Factor for 5%, 2 periods) Year 3:$10 x .86384 = $8.6384 (where .86384 is the PV Factor for 5%, 3 periods) Year 4:$10 x .82270 = $8.2270 (where .82270) is the PV Factor for 5%, 4 periods) Next, we add up all the present values: $9.5238 + $9.0703 + $8.6384 + $8.2270 = $35.4595 Outline Sunday, April 26, 2015 2:35 PM Long-term liabilities should be presented on the balance sheet at thediscounted present value of the future cash payments. Future cash payments: All of these payments we promise to make to the lender Future Value = Present Value x (1 + Rate) $10.50 = $10 x (1.05) 1+5%] [ and n = # of time periods Future Value x 1/(1 + Rate) = Present Value So $10 x 1/(1.05) = $10 x .95238 = $9.5238 Future Value x 1/(1 + Rate)^n = Present Value So $12 x 1/(1.05)^4 = $12 x 1/1.21550 = $12 x .82270 = $9.8724 If I give you the choice of taking $35 now OR $10 at the end of every year for the next four years and money can be invested to earn a 5% rate of return, which would you rather take? Year 1:$10 x .95238 = $9.5238 (where .95238 is the PV Factor for 5%, 1 period) Year 2:$10 x .90703 = 9.0703 (where .90703 is the PV Factor for 5%, 2 periods) Year 3:$10 x .86384 = $8.6384 (where .86384 is the PV Factor for 5%, 3 periods) Year 4:$10 x .82270 = $8.2270 (where .82270) is the PV Factor for 5%, 4 periods) Next, we add up all the present values: $9.5238 + $9.0703 + $8.6384 + $8.2270 = $35.4595 Year 2:$10 x .90703 = 9.0703 (where .90703 is the PV Factor for 5%, 2 periods) Year 3:$10 x .86384 = $8.6384 (where .86384 is the PV Factor for 5%, 3 periods) Year 4:$10 x .82270 = $8.2270 (where .82270) is the PV Factor for 5%, 4 periods) Next, we add up all the present values: $9.5238 + $9.0703 + $8.6384 + $8.2270 = $35.4595 You can either take $35 now or future cash payments worth $35.4595 right now. You’d rather take the annuity payment! Notice each PV Factor was multiplied by $10 (because an annuity is defined as an equal dollar payment.) • $10 x (.95238 + .90703 + .86384 + .82270) = $10 x 3.54595 = $35.4595 Present Value of an Annuity = Annuity Payment Amount x (PVAnnuity Factor from Table C-2) where rate = r% and n = periods FACE VALUE (also called the par value)—this is the amount the issuer of the bond (i.e., the borrower) promises to pay the buyer/bondholder (i.e., the creditor/investor) of the bonds on the maturity date of the bond (so this is a future cash payment or a future value.) Face Value does NOT represent the amount to be borrowed!!! STATED INTEREST RATE—this is the amount of interest the issuer of the bonds promises to pay to the bondholder at periodic regular intervals over the life of the bond; the interest is not given as a dollar amount—it is expressed as a percentage of the Face Value (so this is ALSO a future cash payment or a future value; furthermore, it is an annuity.) Unsecured versus Secured : A secured bond has specific assets of the issuing corporation pledged as collateral—if the issuing corporation defaults on the loan, those assets would be distributed to the bond investors would be able to “sieze” the collateral. Often when issuing unsecured bonds, the issuing corporation may be required to restrict retained earnings or may be required to start funding a “bond sinking fund” used to make the bond payments Term or Serial:Term bonds are bonds issued which all mature on the same date. Serial bonds are bonds issued which mature at different intervals of time. Registered versus Beare : Registered bonds are registered in the name of the bond investor—if the bonds investor sells the bond to another investor, notification must be given to the bond Year 2:$10 x .90703 = 9.0703 (where .90703 is the PV Factor for 5%, 2 periods) Year 3:$10 x .86384 = $8.6384 (where .86384 is the PV Factor for 5%, 3 periods) Year 4:$10 x .82270 = $8.2270 (where .82270) is the PV Factor for 5%, 4 periods) Next, we add up all the present values: $9.5238 + $9.0703 + $8.6384 + $8.2270 = $35.4595 You can either take $35 now or future cash payments worth $35.4595 right now. You’d rather take the annuity payment! Notice each PV Factor was multiplied by $10 (because an annuity is defined as an equal dollar payment.) • $10 x (.95238 + .90703 + .86384 + .82270) = $10 x 3.54595 = $35.4595 Present Value of an Annuity = Annuity Payment Amount x (PVAnnuity Factor from Table C-2) where rate = r% and n = periods FACE VALUE (also called the par value)—this is the amount the issuer of the bond (i.e., the borrower) promises to pay the buyer/bondholder (i.e., the creditor/investor) of the bonds on the maturity date of the bond (so this is a future cash payment or a future value.) Face Value does NOT represent the amount to be borrowed!!! STATED INTEREST RATE—this is the amount of interest the issuer of the bonds promises to pay to the bondholder at periodic regular intervals over the life of the bond; the interest is not given as a dollar amount—it is expressed as a percentage of the Face Value (so this is ALSO a future cash payment or a future value; furthermore, it is an annuity.) Unsecured versus Secured : A secured bond has specific assets of the issuing corporation pledged as collateral—if the issuing corporation defaults on the loan, those assets would be distributed to the bond investors would be able to “sieze” the collateral. Often when issuing unsecured bonds, the issuing corporation may be required to restrict retained earnings or may be required to start funding a “bond sinking fund” used to make the bond payments Term or Serial:Term bonds are bonds issued which all mature on the same date. Serial bonds are bonds issued which mature at different intervals of time. Registered versus Beare : Registered bonds are registered in the name of the bond investor—if the bonds investor sells the bond to another investor, notification must be given to the bond Term or Serial:Term bonds are bonds issued which all mature on the same date. Serial bonds are bonds issued which mature at different intervals of time. Registered versus Beare : Registered bonds are registered in the name of the bond investor—if the bonds investor sells the bond to another investor, notification must be given to the bond issuer so a change in registration can be recorded. Only registered owners will receive interest payments and only the registered owner can transact sales of the bonds to other investors. (So registered bonds much harder to “steal”.) Bearer bonds are not registered in the name of the bond investor—whoever has physical possession of the bond is presumed to be the bond owner. Owners of bearer bonds receive interest by sending in coupons. Convertible and Callable: Some bonds may be issued with a conversion feature which allows the bond investor to exchange the bond for shares of the issuing corporation’s common stock. A corporation would issue convertible bonds to make the bonds more attractive to investors (the conversion feature may allow the issuing corporation to issue at a slightly lower interest rate). Some bonds may be issued with a call feature which allows the bond issuer to buy back the bonds prior to their maturity date at a pre -specified call price. A corporation would issue callable bonds simply to keep their future financing options open —issuing bonds commits the issuer to annual cash payments (the interest) over the life of the bond at a certain ratethe call feature allows the bond issuer to “get out of” these cash payments and to perhaps “refinance” at lower rates. Face Value x (PV Factor from Table C -1) PLUS Stated Interest Payment x (PVAnnuity Factor from Table C-2) Where r = rate and n = periods EQUALS Present Value of the Future Cash Payment EQ UALS BOND PRICE Term or Serial:Term bonds are bonds issued which all mature on the same date. Serial bonds are bonds issued which mature at different intervals of time. Registered versus Beare : Registered bonds are registered in the name of the bond investor—if the bonds investor sells the bond to another investor, notification must be given to the bond issuer so a change in registration can be recorded. Only registered owners will receive interest payments and only the registered owner can transact sales of the bonds to other investors. (So registered bonds much harder to “steal”.) Bearer bonds are not registered in the name of the bond investor—whoever has physical possession of the bond is presumed to be the bond owner. Owners of bearer bonds receive interest by sending in coupons. Convertible and Callable: Some bonds may be issued with a conversion feature which allows the bond investor to exchange the bond for shares of the issuing corporation’s common stock. A corporation would issue convertible bonds to make the bonds more attractive to investors (the conversion feature may allow the issuing corporation to issue at a slightly lower interest rate). Some bonds may be issued with a call feature which allows the bond issuer to buy back the bonds prior to their maturity date at a pre -specified call price. A corporation would issue callable bonds simply to keep their future financing options open —issuing bonds commits the issuer to annual cash payments (the interest) over the life of the bond at a certain ratethe call feature allows the bond issuer to “get out of” these cash payments and to perhaps “refinance” at lower rates. Face Value x (PV Factor from Table C -1) PLUS Stated Interest Payment x (PVAnnuity Factor from Table C-2) Where r = rate and n = periods EQUALS Present Value of the Future Cash Payment EQ UALS BOND PRICE Finally, we are going to compare the bond price to the face value and determine if premium or discount exists—remember this MUST be consistent with our knowledge of the relationship between the stated interest rate and the effective interest rate! NOW we’re ready to account for specific bond transactions as follows: BOND ISSUED AT DISCOUNT IF BOND PRICE LESS THAN FACE VALUE. • We MUST credit the account Bonds Payable for the face value, but remember, we are NOT allowed to record ANY interest right now! • By using the contra-liability account, Discount on Bonds Payable. A bond is issued at a premium when the bond price is greater than the face value. ○ In a premium 8 situation, we have additional borrowing! • Again, the Bonds Payable account is only creditedfor the face value; the additional borrowing is credited to an adjunct-liability account , Premium on Bonds Payable. Finally, we are going to compare the bond price to the face value and determine if premium or discount exists—remember this MUST be consistent with our knowledge of the relationship between the stated interest rate and the effective interest rate! NOW we’re ready to account for specific bond transactions as follows: BOND ISSUED AT DISCOUNT IF BOND PRICE LESS THAN FACE VALUE. • We MUST credit the account Bonds Payable for the face value, but remember, we are NOT allowed to record ANY interest right now! • By using the contra-liability account, Discount on Bonds Payable. A bond is issued at a premium when the bond price is greater than the face value. ○ In a premium 8 situation, we have additional borrowing! • Again, the Bonds Payable account is only creditedfor the face value; the additional borrowing is credited to an adjunct-liability account , Premium on Bonds Payable. AMORTIZING THE ACCT Therefore, in a discount situation, theotal interest expense recorded in any time period equals the stated interestPLUS the discount amortization In a premiumsituation, we have additional borrowing. To adjust the amount of interest that we just recorded and to show that some of the additional borrowing has been repaid, we amortize the premium as follows: Therefore, in apremiumsituation, the total interest expenserecorded in any time period equals the stated interestLESS the premium amortization. Because this is anadjunct liability accounatdded to the Bonds Payable account, the book or carrying value of the bonds is going to ECREASE over the bond term. On the balance sheet in the long-term liability section: AMORTIZING THE ACCT Therefore, in a discount situation, theotal interest expense recorded in any time period equals the stated interestPLUS the discount amortization In a premiumsituation, we have additional borrowing. To adjust the amount of interest that we just recorded and to show that some of the additional borrowing has been repaid, we amortize the premium as follows: Therefore, in apremiumsituation, the total interest expenserecorded in any time period equals the stated interestLESS the premium amortization. Because this is anadjunct liability accounatdded to the Bonds Payable account, the book or carrying value of the bonds is going to ECREASE over the bond term. On the balance sheet in the long-term liability section: Because this is anadjunct liability accounatdded to the Bonds Payable account, the book or carrying value of the bonds is going to ECREASE over the bond term. On the balance sheet in the long-term liability section: ----------------------------------------------------------------------------------------------------------------------------- Total InterestExpense = Bond Price xEffective InterestRate Discount Amortization= TotalInterest Expense – Stated Interest New Carrying Value = Bond Price + Discount Amortization Effective interest method of amortization Straight-line method ofamortization EQUAL DOLLAR AMOUNTof amortization is recorded on each interest payment date: Discount Amortization = Total Discount / Total # of Interest Periods Premium Amortization= Total Premium / Total # of Interest Periods Because this is anadjunct liability accounatdded to the Bonds Payable account, the book or carrying value of the bonds is going to ECREASE over the bond term. On the balance sheet in the long-term liability section: ----------------------------------------------------------------------------------------------------------------------------- Total InterestExpense = Bond Price xEffective InterestRate Discount Amortization= TotalInterest Expense – Stated Interest New Carrying Value = Bond Price + Discount Amortization Effective interest method of amortization Straight-line method ofamortization EQUAL DOLLAR AMOUNTof amortization is recorded on each interest payment date: Discount Amortization = Total Discount / Total # of Interest Periods Premium Amortization= Total Premium / Total # of Interest Periods Straight-line method ofamortization EQUAL DOLLAR AMOUNTof amortization is recorded on each interest payment date: Discount Amortization = Total Discount / Total # of Interest Periods Premium Amortization= Total Premium / Total # of Interest Periods Straight-line method ofamortization EQUAL DOLLAR AMOUNTof amortization is recorded on each interest payment date: Discount Amortization = Total Discount / Total # of Interest Periods Premium Amortization= Total Premium / Total # of Interest Periods

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