BOND ACCOUNTING

Rabia Sharif
 What are bonds?
 Bonds are a form of interest bearing notes
payable.
 They are issued by corporations, governmental
agencies.
 When companies need large funds of long-term
capital to finance some capital intensive projects
they resort to options such as Shares or Bonds
also known a bonds payable in the accounting
books.
 Bonds are basically “Debt” instruments and are
used to break up a large loan into small bits.
Cont..

 Bonds are issued for a long time period

usually 30 -40 years.
 Bonds are transferable i.e. can be sold to
other investors.
 Bonds are often referred to as the fixed
income investments as they pay specific
rate of interest “coupon rate” on the value
of investment.
ADVANTAGES OF BOND FINANCING

 Stockholder’s control is not affected.

Bond holders do not have voting rights, so
current owners retain full control of the
company.
 Tax saving results.
Bond tax is deductible for tax purposes.
 Earning per share may be higher.
No additional shares of common stock are
issued
 Effects on Earning per Share –
Stocks vs. Bonds
• PLAN A PLAN B

Issue stock Issue bonds

Income before interest
& tax $ 1500000 $1500000
Interest (12%x5000000) - 600000
Income before tax 1500000 900000
Tax expense (30%) 450000 270000
Net income 1050000 630000
Outstanding shares 300000 100000
Earnings per share $3.50 $6.30
BOND CHARACTERISTICS
 Face Value:
 Amount of principal the issuer pay at maturity date.

 Interest Rate:
 Referred as Stated Rate is the rate used to determine
the amount of cash interest the borrower pays and the
investor receives. Paid semiannually.

 Bond Indenture:
 The legal document in which the terms of the bond
issue are set forth.
CONT…..

 Call option:
- Can be called back at any time but at a
higher price.
 Convertible Bonds:
Can be converted into a specified number of
shares at the option of the bondholder.
 Bond sinking fund:
A fund created to ensure the investor of the
ability of the corporation to pay back its loans.
TYPES OF BONDS

1. SECURED & UNSECURED BONDS:

SECURED BONDS: Have specific asset of the
issuer pledged as collateral for the bonds.
 A bond secured by real estate is called a Mortgage
Bond.
 A bond secured by specific assets set aside to retire
the bond is called Sinking Fund Bond.
UNSECURED BONDS: Are issued against the
general credit of the borrower.
 These bonds are called Debenture Bonds.
CONT…..

2. TERM & SERIAL BONDS:

TERM BONDS: Bonds that mature at a single specified
future dare.
SERIAL BONDS: Bonds that mature in installments.

3. REGISTERED & BEARER BONDS:

REGISTERED BONDS: Bonds that issue in the name of
the owner.
Interest payments made by checks.
BEARER BONDS: Bonds not registered.
Holders must send coupons to receive interest payments.
CONT….

4. CONVERTIBLE & CALLABLE BODS:

CONVERTIBLE BONDS: Bonds that can be
converted into common stock at the bond
holder’s option.
CALLABLE BONDS: Bonds subject to retirement at
a stated dollar amount prior to maturity at the
option of the issuer.

5. Junk bonds: Bonds issued by companies with a

lesser credit rating. Usually pay very high
interest.
ISSUING PROCEDURES
 State laws grant the power to issue bonds.
 Approval required by board of directors.
 BOD must stipulate:
 Number of bond to be issued
 Face value
 Interest rate.
 Bond indenture prepared
 Bond certificates printed
 Include:
 Name of the issuer
 Face value
 Interest rate
 Maturity date.
 Generally sold through investment company specialized
in bond selling.
MARKET PRICE OF A BOND

 Bond prices are quoted as a percentage of

their face value or maturity value.
 The primary factors which determine the
market value of a bond are:
 The relationship of the bond’s coupon rate to the
market interest rate of similar investments (Market
rate of interest).
 The amount to be received.
 The length of time till the bond matures.
 The investor confidence in the company.
CONT.…

 When ever the price of the bond is more

than its maturity value (face value) it is
said to be selling at Premium.
 When ever the price of the bond is less
than its maturity value (face value) it is
said to be selling at Discount.
ACCOUNTING FOR BOND ISSUES

Bonds may be issued at:

 Face Value
 Below Face Value (at a discount)
 Above Face Value (at a premium)
ISSUING BONDS AT FACE VALUE

 On January 1 Devor issues 1,000, 10 years,

9%, $1,000 bonds.
 Entry to record sale:
Jan 1 Cash 1,000,000
Bonds payable 1,000,000
To record sale of bonds at value.
 Reported in long-term liability section of
balance sheet.
CONT…..

 Interest paid semi annually.

 Entry to record interest payment:
July 1 Bond interest expense 45,000
Cash 45,000
To record payment of bond interest.
($1,000,000 x 9% x 6/12)

 Adjusting entry on December 31:

Dec 31 Bond interest expense 45,000
Bond interest payable 45,000
To accrue bond interest.
ISSUING BONDS ON DISCOUNT OR
PREMIUM
MARKET BONDS SELL
INTEREST RATE AT

8% PREMIUM
BOND
INTEREST
RATE
10% FACE VALUE

10%
12% DISCOUNT
ISSUING BONDS AT A DISCOUNT
On January 1, 2002, Candlestick Inc.
sells $100,000, 5-year, 10% bonds for
$92,639.
Entry:
Jan 1 Cash 92,639
Discount on bonds payable 7,361
Bonds payable 100,000
To record sale of bonds at a discount.
CONT…..

 Balance sheet presentation:

Long-term liabilities:
Bonds payable $100,000
Less: discount on bonds payable 7,361 $92,639

 COST OF BORROWING:
Semiannual interest payments
($100,000 x 10% x ½= $5,000; $5000x10) $50,000
Add: Bond discount (100,000-$92,639) 7,361
Total cost of borrowing $57,361
 CONT…

• COST OF BORROWING:
Principal at maturity $100,000
Semiannual interest payments( $5000x10) 50,000
Cash to be paid to be paid to bondholders 150,000
Cash received from bondholders 92,639
Total cost of borrowing $57,361
ISSUING BONDS AT A PREMIUM

 On January 1, 2002, Candlestick Inc. sells

$100,000, 5-year, 10% bonds for
$108,111.
 Entry:
Jan 1 Cash 108,111
Bonds payable 100,000
Premium on bonds payable 8,111
To record sale of bonds at a premium.
CONT…..

 Balance sheet presentation:

Long-term liabilities:
Bonds payable $100,000
Add: Premium on bonds payable 8,111 $108,111

 COST OF BORROWING:
Semiannual interest payments
($100,000 x 10% x ½= $5,000; $5000x10) $50,000
Less: Bond premium ($108,111-$100,000) 8,111
Total cost of borrowing $41,889
 CONT…

• COST OF BORROWING:
Principal at maturity $100,000
Semiannual interest payments( $5000x10) 50,000
Cash to be paid to be paid to bondholders 150,000
Cash received from bondholders 108,111
Total cost of borrowing $41,889
 ACCOUNTING FOR BOND
RETIREMENT
• REDEEMING BONDS AT MATURITY:
• On January 1, 2002, Candlestick Inc. sells
$100,000, 5-year, 10% bonds at face value.

Bonds payable 100,000

Cash 100,000
To record redemption of bond at maturity.
 CONVERTING BONDS INTO
COMMON STOCK
Assume that on January 1 Saunders
Associates converts $100,000 bonds sold
at face value into 2000 shares of $10 par
value common stock.

Bonds payable 100,000

Common stock 20,000
Paid in capital in excess of par value 80,000
To record bond conversion.