Kế toán, kiểm toán - Chapter 10: Reporting and interpreting bonds

Reporting and Interpreting BondsChapter 10Understanding the Business The mixture of debt and equity used to finance a company’s operations is called the capital structure:Debt - funds from creditorsEquity - funds from ownersCharacteristics of Bonds Payable Advantages of bonds:Stockholders maintain control because bonds are debt, not equity.Interest expense is tax deductible.The impact on earnings is positive because money can often be borrowed at a low interest rate and invested at a higher interest rate.Disadvantages of bonds:Risk of bankruptcy exists because the interest and debt must be paid back as scheduled or creditors will force legal action.Negative impact on cash flows exists because interest and principal must be repaid in the future.Characteristics of Bonds PayableTwo types of cash payment in the bond contract:1. Principal.2. Cash interest payments. Bond TermsPrincipal, par value and face valueContract, stated, or coupon rate of interestMarket, yield, or effective-interest rateCharacteristics of Bonds PayableDebenture bondsNo assets are pledged as guarantee of repayment at maturity.Secured bondsSpecific assets are pledged as guarantee of repayment at maturity.Callable bondsBond may be called for early retirement by the issuer.Convertible bondsBond may be converted to other securities (usually common stock).An indenture is a bond contract that specifies the legal provisions of a bond issue.Characteristics of Bonds PayableThe bond indenture contains covenants designed to protect the creditors.The bond issuer also prepares a prospectus, which describes the company, the bonds, and how the proceeds of the bonds will be used. The trustee makes sure the issuer fulfills all of the provisions of the bond indenture.Reporting Bond Transactions==Times Interest EarnedTimes InterestEarned=Net income + Interest expense + Income tax expenseInterest expenseThe ratio shows the amount of resources generated for each dollar of interest expense. In general, a high ratio is viewed more favorable than a low ratio.Reporting Interest Expense: Straight-line AmortizationIdentify the amount of the bond discount.Divide the bond discount by the number of interest periods.Include the discount amortization amount as part of the periodic interest expense entry.The discount will be reduced to zero by the maturity date.Reporting Interest Expense: Effective-interest AmortizationThe effective interest method is the theoretically preferred method.Compute interest expense by multiplying the current unpaid balance times the market rate of interest.The discount amortization is the difference between interest expense and the cash paid (or accrued) for interest. Zero Coupon BondsZero coupon bonds do not pay periodic interest.This is called a deep discount bond.Because there is no interest annuity, thePV of the Principal = Issue Price of the BondsDebt-to-EquityDebt-to-Equity=Total LiabilitiesStockholders’ EquityThis ratio shows the relationship between the amount of capital provided by owners and the amount provided by creditors. In general, a high ratio suggest that a company relies heavily on funds provided by creditors.Early Retirement of DebtOccasionally, the issuing company will call (repay early) some or all of its bonds.Gains/losses are calculated by comparing the bond call amount with the book value of the bond.Book Value > Retirement Price = GainBook Value < Retirement Price = LossFocus on Cash FlowsFinancing Activities –Issue of bonds (cash inflow)Retire debt (cash outflow)Repay bond principal at maturity (cash outflow)Remember that payment of interest under U.S. GAAP is an operating activity.End of Chapter 10