115 CFA
File: Financial Analysis - Reading 28 - 1. Accounting for Bond Issuance, Bond Amortization, Interest Expense, and Interest Payments

1. Accounting for Bond Issuance, Bond Amortization, Interest Expense, and Interest Payments

a. determine the initial recognition, initial measurement and subsequent measurement of bonds;

b. describe the effective interest method and calculate interest expense, amortisation of bond discounts/premiums, and interest payments;

Current liabilities results from what two things?
1. Operating activities like accounts payable and advances from customers
2. Financing activities like short-term debt (ST) and the current portion of long-term debt (LT).

For accounting, what value is operating and trade debt reported at? For what rule is it an important exception?
Operating and trade debt is reported at the expected (undiscounted) cash flow and is an important exception to the rule that liabilities are recorded at present value.

Advances from customers are a prediction of future cashflow, not a ......... ?
They are not a cash outflow

Long term debt results from ...... ?
Financing activities

What are the two basic accounting principles of long term debt?
1. Debt equals present value of the future interest and principal payments.
2. Interest expense is the amount paid to the creditor in excess of the amount received.

What is a bond premium?
A bond premium represents the amount over the face value of the bond that the issuer never has to return to the bondholders. In effect it reduces the higher-than-market interest rate that the issuer is paying on the bond.

What is a bond discount?
A bond discount represents the amount in excess of the issue price that must be paid by the issuer at the time of maturity. In effect it increases the lower-than-market interest rate the issuer is paying on the bond.

How is the value of a bond determined?
A bond payable is valued at the present value of its future cash flows (periodic coupon payments and principal repayment at maturity). These cash flows are discounted at the market rate of interest at issuance. Therefore, the value of the bond depends on the market rate of interest.

What are payment periods for bonds?

What goes on each accounting statement (income, cash flow, balance sheet statements) when a semi-annual bond coupon payment is made?
- Income statement: interest expense is recorded here
- Cash flow statement: Cash flow from operations (CFO) decreases by the coupon payment.
- Balance sheet: The bond liability is adjusted if necessary.

What is the "interest method" by which a bond premium or discount is amortized over the life of the bond?
The "interest method" results in a constant rate of interest (not a constant interest expense) over the life of the bond. Bond interest expense is increased by amortization of a discount and decreased by amortization of a premium.

If the bond is issued at a premium, interest expense is always ....... ?
....lower than coupon payment, and decreases over time.

If the bond is issued at a discount, interest expense is always ........ ?
.....higher than coupon payment, and increases over time.

If the bond is issued at par, interest expense ....... ?
.....equals coupon payment.

At bond maturity date, what happens?
At the maturity date, the firm repays the face value of the bond.

What are the three steps of the Effective Interest Method for bonds?
1. Bond interest expense is computed first by multiplying the carrying value of the bonds at the beginning of the period by the effective interest rate
2. The bond discount or premium amortization is then determined by comparing the bond interest expense with the interest to be paid.
3. The carrying value of the bond at the end of the period = Beginning Carrying Value - Amortization of Bond Premium (or + Amortization of Bond Discount).

What is a zero-coupon bond?
Zero-coupon bond has no periodic interest payments and is issued at a large discount from par.

What is the major accounting difference between a zero-coupon bond and a par value bond?
Interest on the zero-coupon bond is never reported as cash flow from operations (CFO) because the full amount of the bond is reported as cash flow from financing.

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