ACCT 2302 Chapter 14

Corporations finance their operations using the following sources: *Short-term debt, such as purchasing goods or services on account.*Long-term debt, such as issuing bonds or notes payable.*Equity, such as issuing common or preferred stock
bond is a form of an interest-bearing note. Like a note, a bond requires periodic interest payments, and the face amount must be repaid at the maturity date
Earnings per share (EPS) measures the income earned by each share of common stock. It is computed as follows:Earnings per Share = (Net Income – Preferred Dividends)/Number of Common Shares Outstanding
bond indenture *is the underlying contract between the company issuing bonds and the bondholders *The face amount and the interest rate on the bonds are identified in the bond indenture.
term bonds When all bonds of an issue mature at the same time, they are called term bonds.
serial bonds If they mature over several dates, they are called serial bonds.
convertible bonds Bonds that may be exchanged for other securities are called convertible bonds.
callable bonds. Bonds that a corporation reserves the right to redeem before their maturity are called callable bonds.
debenture bonds Bonds issued on the basis of the general credit of the corporation are called debenture bonds.
When a corporation issues bonds, the proceeds received for the bonds depend on: *The face amount of the bonds, which is the amount due at the maturity date.*The interest rate on the bonds.*The market rate of interest for similar bonds
contract rate or coupon rate. The interest rate to be paid on the face amount of the bond is called the contract rate or coupon rate.
market rate of interest, or effective rate of interest is determined by transactions between buyers and sellers of similar bonds.
The market rate of interest is affected by a variety of factors, including investors’ expectations of current and future economic conditions.
face amount If the market rate equals the contract rate, bonds will sell at the face amount.
discount. If the selling price of the bonds is less than the face amount, the bonds are selling at a discount.
premium If the selling price of the bonds is more than the face amount, the bonds are selling at a premium
The two methods of computing the amortization of a bond discount are: *Straight-line method*Effective interest rate method, sometimes called the interest method*Both methods amortize the same total amount of discount over the life of the bonds.
effective interest rate method The effective interest rate method is required by generally accepted accounting principles.
Callable bonds A corporation may call, or redeem, bonds before they mature. Callable bonds can be redeemed by the issuing corporation within the period of time and at the price stated in the bond indenture. Normally, the call price is above the face value.
carrying amount The carrying amount of bonds payable is the face amount of the bonds less any unamortized discount or plus any unamortized premium.
Bond Redemption *A gain is recorded if the price paid for the redemption is below the bond carrying amount.*A loss is recorded if the price paid for the redemption is above the carrying amount.
An installment note is a debt that requires the borrower to make equal periodic payments to the lender for the term of the note
a note payment includes the following *Payment of a portion of the amount initially borrowed, called the principal*Payment of interest on the outstanding balance
Installment notes are often used to purchase specific assets, such as equipment, and are often secured by the purchased asset.
mortgage note When a note is secured by an asset, it is called a mortgage note.
If the borrower fails to pay a mortgage note, the lender has the right to take possession of the pledged asset.
number of times interest charges are earned = (Income Before Income Tax + Interest Expense)/Interest Expense
When a corporation issues bonds, the price that investors are willing to pay for the bonds depends on the following: *The face amount of the bonds, which is the amount due at the maturity date.*The periodic interest to be paid on the bonds. *The market rate of interest.
time value of money concept The time value of money concept recognizes that an amount of cash received today is worth more than the same amount of cash to be received in the future.
Present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return
future value The amount to be received in the future if you make a deposit now is the
annuity. A series of equal cash receipts spaced equally in time is called an annuity
present value of an annuity The present value of an annuity is the sum of the present values of each cash receipt.
effective interest rate method The effective interest rate method of amortization, sometimes called the interest method, provides for a constant rate of interest over the life of the bonds.
One potential advantage of financing corporations through the use of bonds rather than common stock is the interest expense is deductible for tax purposes by the corporation
A bond indenture is a contract between the corporation issuing the bonds and the bond trustee , who is acting on behalf of the bondholders.
Debenture bonds are issued on the general credit of the corporation and do not pledge specific assets as collateral.
If the market rate of interest is 8%, the price of 6% bonds paying interest semiannually with a face value of $100,000 will be Less than $100,000
The present value of $40,000 to be received in one year, at 6% compounded annually, is (rounded to nearest dollar) $37,736
When the market rate of interest on bonds is higher than the contract rate, the bonds will sell at a discount
The interest rate specified in the bond indenture is called the contract rate
An unsecured bond is the same as a debenture bond
The Mansur Company issued $100,000 of 12% bonds on May 1, 2007 at face value. The bonds pay interest semiannually on January 1 and July 1. The bonds are dated January 1, 2007, and mature on January 1, 2011. The total interest expense related to these bonds for the year ended December 31, 2007 is $8,000
The entry to record the amortization of a premium on bonds payable is debit Interest Expense, debit Premium on Bonds Payable, credit Cash
describe the 2 distinct obligations incurred by a corporation when issuing bonds (1) To pay the face (maturity) amount of the bonds at a specified date. (2) To pay periodic interest at a specified percentage of the face amount.
explain the meaning of each of following terms as they relate to a bond issue: convertible, callable and debenture a. Bonds that may be exchanged for other securities under specified conditions.b.The issuing corporation reserves the right to redeem the bonds before the maturity date.c. Bonds issued on the basis of the general credit of the corporation.
if you asked your broker to purchase for you a 12% bond when the market interest rate for such bonds was 11%would you expect to pay more or less than the face amount for the bond? More than face amount. Because comparable bonds provide a market interest rate (11%) that is less than the rate on the bond being issued (12%), the bond will sell at a premium as the market’s means of equalizing the two interest rates.
a corporation issues $26,000,000 of 9% bonds to yield interest at the rate of 7%. (a) was the amount of cash received from the sale of the bonds greater or less than $26,000,000? Greater than $26,000,000
(b) identify the following amounts as they relate to the bond issue: face amount, mkt it effective rate of interest, contract rate of interest, and maturity rate? $26,000,0007%9%$26,000,000
if bonds issued by a corporation are sold at a premium, is the market rate if interest greater or less than raw contract rate? less than contract rate
$15,000,000, 10% bond issued or a semiannual interest period: Bond carrying amount at beginning of period $15,593,454interest paid during period 750,000interest exp allocable to the period 809,345 (a) were the bonds issued at a discount or at a premium? (b) what is the unamortized amount of the discount or premium account at the beginning of the period? (c) what account was debited to amortize the discount or premium? a. Premiumb. $593,454c. Premium on Bonds Payable
bonds payable has as a balance of $5,000,000 and discount on bonds payable has a balance of $150,000. If the issuing corporation redeems the bonds at 98, is there a gain to loss on the bonds redemption? A loss of $50,000 [($5,000,000 × 0.98) – ($5,000,000 – $150,000)]
what is mortgage note? A mortgage note is an installment note that is secured by a pledge of the borrower’s assets.If the borrower fails to pay the note, the lender has the right to take possession of the pledged asset and sell it to pay off the debt.
Fleeson comment needs additional funds to purchase equipment for a new production facility and is considering either issuing bonds payable or borrowing the money from a local bank in the form of an installment note. how does an installment note differ from a bond payble A bond is an interest-bearing note that requires periodic interest payments and repayment of the face amount of the bonds at maturity. Bonds consist of two different components:(1) interest payments made periodically over the life of the bond and (2) the face amount that must be repaid at maturity. The periodic payments consist entirely of interest, and the final payment at maturity consists entirely of principal. Installment notes, on the other hand, have periodic payments that consist partially of interest and partially of principal. Each payment reduces the principal on the note so that at maturity the entire amount borrowed will have been repaid.
in what section of the balance sheet would a bond payable be reported if: it is payable within one year and it is payable beyond one year? a. As a current liability on the balance sheet.b. As a long-term liability on the balance sheet.

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