ILLUSTRATION 14-1 - Wiley

ILLUSTRATION 14-1 INTEREST RATES AND BOND PRICES

Market Interest Rate (1) Stated interest Rate 12%

Bond Issued at

(2) (3)

Bonds Sold At

10%

Premium

12%

Face Value

15%

Discount

Source: Adapted from Weygandt, Kieso, and Kell, Accounting Principles, Third Edition, p. 673.

EXAMPLE: Three year bonds are issued at face value of $100,000 and a stated rate interest of 12%.

(1) Bonds are issued to yield 10%

Present value of principal (Table 6-2) FV ´ (PVF3,10%) = $100,000 ´ .75132 =

$75,132

Present value of interest payments (Table 6-4) R ´ (PVF-OA3,10%) = $12,000 ´ 2.48685 = Selling price of bonds (premium)

Copyright © 1998 John Wiley & Sons, Inc.

Kieso/Intermediate 9e

29,842

$104,974

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ILLUSTRATION 14-1 (continued)



$71,178

Present value of interest payments (Table 6-4) R ´ (PVF-OA3,12%) = $12,000 ´ 2.40183 = Selling price of bonds (par)

28,822

$100,000



$65,752

Present value of interest payments (Table 6-4) R ´ (PVF-OA3,15%) = $12,000 ´ 2.28323 = Selling price of bonds (discount)



27,399

$93,151

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ILLUSTRATION 14-2 BOND AMORTIZATION METHODS

Computation of Amortization-—Straight-Line Method Bond Discount or Premium

Interest Payable

÷

®

Constant Amount

Number of Interest Periods

=

Bond Amortization

+Discount – Premium Amortization

=

Interest Expense

Constant Amount

Constant Amount

Computation of Amortization-—Effective Interest Method Bond Interest Payable Face Amount ´ of Bonds

Stated Interest Rate

Constant Amount

Bonds Interest Expense Carrying Value ´ of Bonds Beginning of Period

–

Effective Interest Rate

Premium-—Decreasing Amount Discount-—Increasing Amount



=

Amortization Amount

Decreasing Amount Increasing Amount

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ILLUSTRATION 14-3 ACCOUNTING FOR BONDS Three-year bond with an 8% coupon rate sold to yield 10% on January 1, 1997. Interest payable annually on December 31. Callable at 105. Face value: $100,000. Bond issue costs: $5,000. 1. Calculation of premium or discount. $100,000 (0.75132) = $75,132 (Present value of principal, Table 6-2) $ 8,000 (2.48685) = 19,895 (Present value of interest, Table 6-4) $95,027 (Selling price of bond) Discount = $100,000 – $95,027 = $4,973. 2. Recording of bond issuance. Cash………………………………. Bond Issue Costs………………… Discount on Bonds………………… Bonds Payable………………….

90,027 5,000 4,973 100,000

3. Bond Discount Amortization. Interest Interest Pay. (8%) Expense (10%) 01/01/97 12/31/97 12/31/98 12/31/99

8,000 8,000 8,000

9,503 9,653 9,817

Discount Bond Face Val. Amortization Discount of Bonds 4,973 3,470 1,817 –0–

1,503 1,653 1,817

100,000 100,000 100,000 100,000

Car. Val. of Bonds 95,027 96,530 98,183 100,000

4. Accounting entries. 12/31/97 Interest Expense Discount on Bonds Cash

9,503

Bond Issue Expense Bonds Issue Costs

1,667

12/31/98 9,653

1,503 8,000

Bonds Payable Cash


9,817 1,653 8,000

1,667 1,667

12/31/99 1,817 8,000 1,666

1,667

1,666 100,000 100,000


104

ILLUSTRATION 14-4 (continuation of problem in Illustration 14-3) EXTINGUISHMENT OF DEBT Three year 8% bonds of $100,000 are recalled at 105 on December 31, 1998. Expenses of recall: $2,000.

General ledger account balances at 12/31/98: Bond Issue Cost 1/1/97

Bal. 12/31/98

$5,000

12/31/97 12/31/98

Bonds Payable $1,667 1,667

12/31/98 $100,000

$1,666

Discount on Bonds Payable 1/1/97

Bal. 12/31/98

$4,973

12/31/97 12/31/98

$1,503 1,653

$1,817

ANALYSIS: Cash paid Net carrying amount of bonds Loss on extinguishment

= (1.05 ´ $100,000) + $2,000 = $107,000. = ($100,000 – $1,817 – $1,666) = $96,517. = $107,000 – $96,517 = $10,483.

JOURNAL ENTRY: Bonds Payable………………………………………………… Loss on Extinguishment……………………………………… Cash………………………………………………………. Discount on Bonds………………………………………. Bond Issue Costs…………………………………………



100,000 10,483 107,000 1,817 1,666

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ILLUSTRATION 14-5 SUMMARY OF ACCOUNTING FOR TROUBLED DEBT

EVENT

DEBTOR

CREDITOR

1. Impairment

No recognition

Loss based upon difference between PV of future cash flows discounted at historical effective interest rate and carrying amount of note. Recognize interest revenue (or bad debt expense reduction) based upon new carrying amount and original effective rate.

Recognize gain on restructure and gain or loss on asset transfer. Recognize gain on restructure.

Recognize loss on restructure.

2. Restructuring-— Settlement of Debt (a) Transfer of noncash assets. (b) Granting of equity interest. 3. Restructuring-— Modification of Terms (a) Carrying amount of debt < future cash flows

(b) Carrying amount of debt > future cash flows

Recognize no gain on restructure. Determine new effective interest rate to be used in recording interest expense.

Recognize loss on restructure.

For both situations: Recognize loss based upon PV of restructured cash flows. Recognize interest revenue based upon new recorded value and original effective rate.

Recognize gain on restructure and reduce carrying amount to the sum of the undiscounted cash flows. Recognize no interest expense over the remaining life of the debt.

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