University:
California State University, Northridge
Course:
ACCT 352 | Intermediate Financial Accounting III
Academic year:

2024
Views:

149

Pages:

20
Author:

Brennen Smith

14-1 Bonds and Long-Term Notes Chapter 14 Part 2 14-21 Debt Issue Costs Legal  Accounting  Underwriting  Commission  Engraving  Printing  Registration  Promotion  14-22 U. S. GAAP vs. IFRS Debt issue costs (called transaction costs under IFRS) are accounted for differently by U.S. GAAP and IFRS. • Debt issue costs are recorded separately as an asset.   • Amortized over the term to maturity. “Transaction costs” reduce the recorded amount of the debt. The cost of these services reduces the net cash the issuing company receives and the amount recorded for the debt. Unless the recorded amount of the debt is reduced by the transaction costs, the higher effective interest rate is not reflected in a higher recorded interest expense. 14-23 Long-Term Notes Company (Borrower) Promissory Note (Note Payable) Bank Property, goods, or services. The liability, note payable, is reported at its present value, similar to the accounting for bonds payable. 14-24 Long-Term Notes On January 1, 2013, Skill Graphics, Inc., a product labeling and graphics firm, borrowed $700,000 cash from First BancCorp and issued a 3-year, $700,000 promissory note. Interest of $42,000 was payable semiannually on June 30 and December 31. January 1, At Issuance Skill Graphics (Borrower) Cash Note payable 700,000 First BancCorp (Lender) Note receivable Cash 700,000 700,000 700,000 14-25 Long-Term Notes At Each of the Six Interest Dates Skill Graphics (Borrower) Interest expense Cash 42,000 First BancCorp (Lender) Cash Interest revenue 42,000 42,000 42,000 At Maturity Skill Graphics (Borrower) Notes payable Cash 700,000 First BancCorp (Lender) Cash Notes receivable 700,000 700,000 700,000 14-26 Note Exchanged for Assets or Services Skill Graphics purchased a package labeling machine from Hughes– Barker Corporation by issuing a 12%, $700,000, 3-year note that requires interest to be paid semiannually. The machine could have been purchased at a cash price of $666,633. The cash price implies an annual market rate of interest of 14%. That is, 7% is the semiannual discount rate that yields a present value of $666,633 for the note’s cash flows (interest plus principal) computed as follows: Present value of an ordinary annuity of $1: n=6, i=7% Interest Principal $ 42,000 × 4.76654 = $700000 × 0.66634 = Present value (price) of note Present Values $ 200,195 466,438 $ 666,633 present value of $1: n=6, i=7% The accounting treatment is the same whether the amount is determined directly from the market value of the machine or indirectly as the present value of the note. 14-27 Note Exchanged for Assets or Services At the Purchase Date (January 1) Skill Graphics (Buyer/Issuer) Machinery 666,633 Discount on note payable 33,367 Notes payable 700,000 Hughes-Barker (Seller/Lender) Notes receivable 700,000 Discount on notes payable 33,367 Sales revenue 666,633 At the First Interest Date (June 30) Skill Graphics (Buyer/Issuer) Interest expense 46,664 Discount on note payable 4,664 Cash 42,000 Hughes-Barker (Seller/Lender) Cash 42,000 Discount on notes payable 4,664 Investment revenue 46,664 14-28 Installment Notes To compute cash payment use present value tables. o Each payment includes both an interest amount and a principal amount. o Interest expense or revenue: o Effective interest rate × Outstanding balance of debt Interest expense or revenue o Principal reduction: Cash amount – Interest component Principal reduction per period 14-29 Installment Notes Notes often are paid in installments, rather than a single amount at maturity. $666,633 amount of loan Date 01/01/13 06/30/13 12/31/13 06/30/14 12/31/14 06/30/15 12/31/15 Cash ÷ 4.76654 (from Table 4) n=6, i=7.0% Effective Interest (7% × Outstanding Balance) = $139,857 installment payment Decrease in Debt 139,857 139,857 139,857 139,857 139,857 139,857 .07 × 666,633 = 46,664 .07 × 573,440 = 40,141 .07 × 473,724 = 33,161 .07 × 367,028 = 25,692 .07 × 252,863 = 17,700 .07 × 130,706 = 9,151 93,193 99,716 106,696 114,165 122,157 130,706 839,142 172,509 666,633 Rounded Outstanding Balance 666,633 573,440 473,724 367,028 252,863 130,706 - 0 14-30 Installment Notes At the Purchase Date (January 1) Skill Graphics (Buyer/Issuer) Machinery 666,633 Notes payable 666,633 Hughes-Barker (Seller/Lender) Notes receivable Sales revenue 666,633 666,633 At the First Interest Date (June 30) Skill Graphics (Buyer/Issuer) Interest expense 46,664 Note payable 93,193 Cash 139,857 Hughes-Barker (Seller/Lender) Cash Notes receivable Interest revenue 139,857 93,193 46,664 14-31 Financial Statement Disclosures Matrix Inc. Partial Balance Sheet December 31, 2013 Long-term liabilities: Bonds payable, face amount Less: unamortized discount Less: unamortized issue costs Bonds payable, net $ 50,000,000 (244,875) (127,500) $ 49,627,625 Disclosures include fair value, the nature of the company’s liabilities, interest rates, maturity dates, call provisions, conversion options, restrictions imposed by creditors, any assets pledged as collateral, and the aggregate amounts payable for each of the next five years. 14-32 Decision Makers’ Perspective Debt to Total liabilities = equity ratio Shareholders’ equity Rate of return on = assets Net income Total assets Rate of return on Net income = shareholders’ equity Shareholders’ equity Times interest = Net income + interest + taxes earned ratio Interest 14-33 Early Extinguishment of Debt Debt retired at maturity results in no gains or losses. BUT Debt retired before maturity may result in an gain or loss on extinguishment. Cash Proceeds – Book Value = Gain or Loss 14-34 Early Extinguishment of Debt Illustration – On January 1, 2013, Masterwear Industries called its $700,000, 12% bonds when their carrying amount was $676,290. The indenture specified a call price of $685,000. The bonds were issued previously at a price to yield 14%. Masterwear (Issuer) Bonds payable Loss on early extinguishment Discount on bonds payable Cash $685,000 – 676,290 700,000 8,710 23,710 685,000 $700,000 – 676,290 14-35 Convertible Bonds Some bonds may be converted into common stock at the option of the holder. When bonds are converted the issuer (1) updates interest expense and (2) amortization of discount or premium to the date of conversion. The bonds are reduced and shares of common stock are increased. Bonds into Stock 14-36 Convertible Bonds On January 1, 2013, HTL Manufacturers issued $100,000,000 of 8% convertible debentures due 2033 at 103 (103% of face value). The bonds are convertible at the option of the holder into $1 par common stock at a conversion ratio of 40 shares per $1,000 bond. HTL recently issued nonconvertible, 20 year, 8% debentures at 98. At Issuance, January 1, 2013 HTL (Issuer) Cash Convertible bonds payable Premium on bonds payable 103,000,000 100,000,000 3,000,000 $100,000,000 × 103% 14-37 Convertible Bonds Assume the bondholder exercises one-half of their option to convert the bonds into shares of stock when there is an unamortized premium of $2,000,000 associated with these bonds. The bonds are removed from the accounting records and the new shares issued are recorded at the same amount (in other words, at the book value of the bonds). At Date of Exercise of One-half of the Bonds HTL (Issuer) Convertible bonds payable Premium on bonds payable Common stock Paid-in capital – excess of par 50,000,000 1,000,000 2,000,000 49,000,000 50,000 bonds × 40 shares × $1 par = $2,000,000 par value 14-38 Induced Conversion Companies sometimes try to induce conversion. The motivation might be to reduce debt and become a better risk to potential lenders or achieve a lower debt-to-equity ratio. When the specified call price is less than the conversion value of the bonds (the market value of the shares), calling the convertible bonds provides bondholders with incentive to convert. 14-39 U.S. GAAP vs. IFRS Convertible Bonds Under IFRS, unlike U.S. GAAP, convertible debt is divided into its liability and equity elements. ($ in millions) Cash (103% × $100 million) Convertible bonds payable (value of the debt only) Equity–conversion option (difference) 103 98* 5 *The discount is combined with the face amount of the bonds. This is the “net method” – the preferred method under IFRS.  Compound instruments such as this one are separated into their liability and equity components in accordance with IAS No. 32.  If the bonds have a separate fair value of $98 million, we record that amount as the liability and the remaining $5 million as equity.

Bonds and Long-Term Notes, Part 2

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