Accounting for Long - term Debt

Instruments and Investments

Instructor: Mussa J Assad

 Who borrows long term?
• All types of organisations;
• Governments;
• Corporate entities;
• Not-for-profit organisations.

Why borrow long term?

• To finance acquisition of fixed assets,
new businesses, restructuring, or
expansion.
Relating long-term debt and
investments
• Issuer [Borrower] • Lender [Investor]

Balance Sheet Balance Sheet

Fixed Assets Fixed Assets
Net Current Assets Investments
Capital Employed Net Current Assets
Capital Employed
Financed by:
Long-term Debt Financed by:
Share Capital Long-term Debt
Total Capital Share Capital
Total Capital
 What is a Bond?
• Also known as a Debenture;
• A certificate, issued by a borrower
[issuer] to a lender [bondholder];
• Exchange for a sum of money [Bond
price];
• It attracts periodic interest, stated
on the certificate;
• Its face value is repayable on Bond
maturity.
 Features of a Bond?
• Par value [also known as Face
value];
• Issue date [interest starts here];
• Maturity date;
• Stated rate of interest;
• Hence P*R*T gives you interest.
 Types of Bonds?
• Secured versus Unsecured Bonds;
• Convertible Bonds;
• Redeemable Bonds;
• Registered versus Unregistered
Bonds.

Bond rating services

 Types of Bond Issues?
• Bonds issued at Par, (100) -stated
interest equals Market rate of
interest;
• Bonds issued at a Discount, (88.5) -
stated rate of interest lower than
Market rate of interest;
• Bonds issued at a Premium, (110) -
stated rate of interest higher than
Market rate of interest.
 Events for accounting
entries

• Issue of a bond;
• Payment of bond interest;
• End of year adjustments for interest
expense;
• Amortisation of Bond Discount or
Premium.
 Figures for accounting entries

Date Details Par Discount Premium

1.1 Cash received 4,000,000 3,540,000 4,400,000

30.6 Interest payment 200,000 200,000 200,000

31.12 Interest payment 200,000 200,000 200,000

31.12 Interest expense 400,000 ? ?
Interest charge: Discount scenario
Cash outflows:
Maturity value 4,000,000
Interest payments, 10 years 4,000,000
Total amount paid 8,000,000
Total amount received 3,540,000
Total 10-year interest expense 4,460,000
Annual interest expense 446,000
Semi-annual interest expense 223,000

Semi-annual interest payment 200,000

Semi-annual interest top up 23,000

 Journal entries: Discount scenario

Date Details Debit Credit

1.1 Cash 3,540,000
Discount on Bonds 460,000
Bonds Payable 4,000,000

30.6 Interest expense 200,000

Cash 200,000
Interest expense 23,000
Discount on Bonds 23,000

31.12 Repeat above entry

31.12 Interest expense to P&L 446,000

Interest charge: Premium scenario
Cash outflows:
Maturity value 4,000,000
Interest payments, 10 years 4,000,000
Total amount paid 8,000,000
Total amount received 4,400,000
Total 10-year interest expense 3,600,000
Annual interest expense 360,000
Semi-annual interest expense 180,000

Semi-annual interest payment 200,000

Semi-annual interest reduction 20,000

 Journal entries: Premium scenario

Date Details Debit Credit

1.1 Cash 4,400,000
Premium on Bonds 400,000
Bonds Payable 4,000,000

30.6 Interest expense 200,000

Cash 200,000
Premium on Bonds 20,000
Interest expense 20,000

31.12 Repeat above entry

31.12 Interest expense to P&L 360,000

 Balance Sheet [extracts only]

Par Discount Premium

Long term liabilities:

Bonds Payable 4,000,000 4,000,000 4,000,000

Less: Discount on Bonds - (414,000) -

Add: Premium on Bonds - - 360,000

4,000,000 3,586,000 4,360,000

More events for accounting
entries

• Bonds issued between interest dates;

• Accruing bond interest;
• End of year adjustments;
• Amortisation of Bond Discount or
Premium;
• Accounting entries for Bond
Investments.
 Example of Bonds issued
between interest dates
• Mzee Publishers [page 281];
• 500 bonds;
• Date of Issue - 1st January, Y-01;
• Actual Date of Issue - 1st April Y-01;
• At 100 [meaning at Par]
• Interest payable June 30, December 31;
• What happens to the 3 months interest?
 Graphic representation

30.6.Y01 31.12.Y01 31.12.Y10

1.1.Y01 1.04.Y01

12,500 12,500
3 months 3 months
interest interest

1st 6 months 2nd 6 months

9 YEARS
Bond Price that includes interest

Amount

500 Bonds at Par 500,000

Interest for 3 months 12,500

Total cash received 512,500

 Journal entries: Bond price that
includes interest

Date Details Debit Credit

1.4 Cash 512,500

Bonds Payable 500,000
Interest Expense 12,500

30.6 Interest expense 25,000

Cash 25,000
 Example of Accruing Bond
Interest
• Mzee Publishers [page 282];
• 500 bonds;
• Date of Issue - 1st April, Y-01;
• Interest Payable March 31 and
September 30;
• Actually issued on 1st October Y-01;
• At 90 [meaning at a Discount].
 Graphic representation

31.12.Y01

1.4.Y01 1.10.Y01 31.03.Y02 31.03.Y10

3 months 3 months

1st 6 months 2nd 6 months

Bond not in issue Bond now in issue 9 YEARS

Interest charge: Discount scenario
Cash outflows:
Maturity value 500,000
Interest payments, 9.5 years 475,000
Total amount paid 975,000
Total amount received 450,000
Total 9.5-year interest expense 525,000
Annual interest expense 55,263
Semi-annual interest expense 27,631

Semi-annual interest payment 25,000

Semi-annual interest top up 2,631

 Journal entries: Discount scenario

Date Details Debit Credit

1.10 Cash 450,000
Discount on Bonds 50,000
Bonds Payable 500,000

31.12 Interest expense 13,815.50

Accrued Interest payable 12,500.00
Discount on Bonds 1,315.50

31.03 Interest expense 13,815.50

Accrued Interest payable 12,500.00
Discount on Bonds 1,315.50
Cash 25,000.00
Relating long-term debt and
investments
• Issuer [Borrower] • Lender [Investor]

Balance Sheet Balance Sheet

Fixed Assets Fixed Assets
Net Current Assets Investments
Capital Employed Net Current Assets
Capital Employed
Financed by:
Long-term Debt Financed by:
Share Capital Long-term Debt
Total Capital Share Capital
Total Capital
Classification of Investments
• Short term • Long term
Investments Investments
• Marketable • Normally non-
securities; marketable securities;
• Easily converted • Not easily converted
into cash; into cash;
• Intention is short • Intention is long term.
term.
Events for accounting entries
• Purchase of an Investment;
• Receipt of Bond interest;
• End of year adjustments for interest
income;
• Amortisation of Bond Discount or
Premium.
Example of Bond Investment

• Ruth Maila [page 285];

• Date of purchase 1st July Y-05
• TAS. 2,000,000 bonds;
• Original issue - 1st July, Y-01;
• Maturity date 30th June Y-11?;
• 25% Interest payable annually on
30th June;
• Accounting year-end 31st December.
 Entries: Investment at Par

Date Details Debit Credit

1. 07 Bond Investments 2,000,000
Cash 2,000,000

31.12 Bond Interest receivable 250,000

Bond Interest income 250,000

30.06 Cash 500,000

Y-06 Bond Interest receivable 250,000
Bond Interest income 250,000
30.06 Cash 2,000,000
Y-11
Bond Investments 2,000,000
 Entries: Investment at a Discount
Date Details Debit Credit
1. 07 Bond Investments 2,000,000
Cash 1,900,000
Discount on Bonds 100,000
31.12 Bond Interest receivable 250,000
Discount on Bonds 10,000
Bond Interest income 260,000

30.06 Cash 500,000

Y-06 Discount on Bonds 10,000
Bond Interest receivable 250,000
Bond Interest income 260,000
30.06 Cash 2,000,000
Y-11
Bond Investments 2,000,000
 Entries: Investment at a Premium
Date Details Debit Credit
1. 07 Bond Investments 2,000,000
Premium on Bonds 100,000
Cash 2,100,000
31.12 Bond Interest receivable 250,000
Premium on Bonds 10,000
Bond Interest income 240,000

30.06 Cash 500,000

Y-06 Premium on Bonds 10,000
Bond Interest receivable 250,000
Bond Interest income 240,000
30.06 Cash 2,000,000
Y-11
Bond Investments 2,000,000
 Balance Sheet [extracts only]
Par Discount Premium
Current Assets:
Interest Receivable 250,000 250,000 250,000

Investments:
Bond Investments 2,000,000 2,000,000 2,000,000

Less: Discount on Bonds - (90,000) -

Add: Premium on Bonds - - 90,000

Amortized Cost 2,000,000 1,910,000 2,090,000

 Example of Bonds bought
between interest dates
• The opposite of Bonds Payable [page
289];
• Include interest for period bond not
owned in the purchase price;
• Debit, Bond Investments with Face
Value* Debit, Interest Income with
Interest component* Credit, Cash
with full price.
 Sale of Bond Investment

• Same principles as in Disposal of Fixed

Assets;
• Sales Price must be net of selling costs
and commissions;
• Cost of Investment must be brought up
to date; Amortise to the date of sale AND
close any Discounts or Premium;
• GAIN; Sales > Amortised Cost;
• LOSS; Sales < Amortised Cost.