A Free sample background from www. awesomebackgrounds. com INTERMEDIATE FINANCIAL ACCOUNTING II Welcome to ACCT 352! © 2006 By Default! Slide 1
Slide 2 A Free sample background from www. awesomebackgrounds. com PART I: OVERVIEW FINANCING DEBT (Chapter 14) EQUITY (CHAPTER 18) Recording/ Retirement Conversion Warrants Reporting/Fair Value REPORTING BASIC/DILUTIVE EARNINGS PER SHARES (CHAPTER 19) © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com KNOWLEDGE KEY POINTS: q FINANCIAL REPORTING ü ü Bigger picture Outside the box External impact Global impact Expand your knowledge: Read/listen/watch News © 2006 By Default! Slide 3
A Free sample background from www. awesomebackgrounds. com CURRENT US MARKET CURRENT ECONOMIC CONDITIONS DISCUSSION: Ø Current US economic conditions? Ø Is US the most important economy in the world? E. g. crisis? Ø Why is it important? Ø Impact on Corporations Globally Ø © 2006 By Default! Slide 4
A Free sample background from www. awesomebackgrounds. com FINANCIAL REPORTING & ECONOMICS What is : CAPITAL MARKET? ü‘Who are the key players? ü‘ ü‘ üWhich market is bigger? © 2006 By Default! Slide 5
BOND MARKET! A Free sample background from www. awesomebackgrounds. com n New York Stock Exchange (NYSE) is the Slide 6 largest centralized bond market, representing mostly corporate bonds. ü Why is it important for us to know the US/Global perspective of BOND/STOCK MARKET? Source: Securities Industry & Financial Markets Association (SIFMA) © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com LONG TERM FINANCING CORPORATION’S PERSPECTIVE OPTIONS: ISSUE: PRO/CON 1. 1. © 2006 By Default! BOND MARKET STOCK MARKET Slide 7
A Free sample background from www. awesomebackgrounds. com MAJOR DIFFERENCES: Debt Financing & Equity Financing © 2006 By Default! Slide 8
A Free sample background from www. awesomebackgrounds. com NATURE OF BONDS Bond Certificates- Bond borrowing agreement: Indenture or covenants Professor Vedd © 2006 By Default! Slide 9
Slide 10 A Free sample background from www. awesomebackgrounds. com Bonds At Bond Issuance Date Company Issuing Bonds Bond Selling Price Investor Buying Bonds Bond Certificate Subsequent Periods Company Issuing Bonds Interest Payments Face Value Payment at End of Bond Term © 2006 By Default! Investor Buying Bonds
Slide 11 A Free sample background from www. awesomebackgrounds. com The Bond Indenture Debenture Bond secured by the “full faith and credit” of company. unsecured Mortgage Bond secured by lien on specific real estate owned by the issuer. The specific promises made to bondholders are described in a document called a bond indenture. Coupon Bond pays interest when investor submits attached coupon. © 2006 By Default! Callable Bond allows company to buy back outstanding bonds prior to maturity.
Slide 12 A Free sample background from www. awesomebackgrounds. com PROVISIONS: BONDS n Callable/Redeemable n Convertible Professor Vedd © 2006 By Default! bonds:
ACCOUNTING FOR BONDS A Free sample background from www. awesomebackgrounds. com BONDS: ü Recording/Reporting/Issue of bonds ü Interest payment/accruals (during the term ü Presentation/disclosures ü Reporting Changes in Fair Value RETIREMENT: ü Prior to Maturity CONVERSION: üConvert Bonds to Stock üSTOCK WARRANTS © 2006 By Default! Slide 13
A Free sample background from www. awesomebackgrounds. com US GAAP & IFRS LONG TERM DEBT US GAAP: n APB Opinion 21 (Issue costs) & n APB Opinion 14 (convertible debt) n SFAS No 159/157: The Fair Value Option n FASB ASC Topic 470 / IAS 1 IFRS: IAS 32 & 39 © 2006 By Default! Slide 14
FEATURES OF BONDS A Free sample background from www. awesomebackgrounds. com Slide 15 FACE VALUE: n Nominal/principal n Par value or maturity value. MATURITY DATE INTEREST RATE: n Rate Printed on Bond: Stated/face/coupon/nominal rate Determines cash interest payments • Market Interest Rate (effective rate) (Yield) Rate in effect when bonds are issued © 2006 By Default!
DETERMINE PRICE OF BONDS A Free sample background from www. awesomebackgrounds. com TWO WAYS: 1. NYSE/WSJ etc • Quoted: percentage of face amount Bonds are quoted as a % of face value e. g. 98 © 2006 By Default! Slide 16
DETERMINE PRICE OF BONDS A Free sample background from www. awesomebackgrounds. com Slide 17 TWO WAYS: 2. PRESENT VALUE (PV) PV of the future cash flows: = A. PV: interest: annuity PAYMENT (Stated Interest Rate) plus B. PV of the Face/Par Value • Discounted at the market (yield) rate of interest in effect at issue date. © 2006 By Default!
Slide 18 A Free sample background from www. awesomebackgrounds. com Bond Interest Rates Bond Stated Rate = 9% Market Rate = 8% Market Rate = 9% Market Rate = 10% Bonds Sell at a Premium Bonds Sell At Par (Face) Bonds Sell at a Discount © 2006 By Default!
Slide 19 A Free sample background from www. awesomebackgrounds. com Bond Valuation ILLUSTRATION Year 1 $9, 000 $ 33, 263 plus $ 59, 345 Year 2 $9, 000 Year 3 $9, 000 Year 5 $9, 000 Discount at market rate, 11% rate $9, 000 * 3. 69590 Discount at market rate, 11% rate $100, 000 * 0. 59345 =$92, 608 is the issue price © 2006 By Default! Year 4 $100, 000
A Free sample background from www. awesomebackgrounds. com Slide 20 In Class Illustration: Example A On January 1, 2012, JJ Corporation issues $500, 000 longterms bonds with stated interest rate of 10%, due on January 1, 2017. Interest is paid semiannually on January 1 and July 1 each year. At the time of issuance, market interest rate is 12%. December 31 year-end Step 1: Calculate the price of the bond Step 2: Record the issue of bonds Jan 1, 2012 Step 3: Prepare schedule of interest expense Step 4: Record entries for interest expense/payments for 2012 Step 5: Presentation: statement December 31, 2012 © 2006 By Default!
Cont. Example A: Calculating the Price of the Bond A Free sample background from www. awesomebackgrounds. com Slide 21 PV of interest payments PV: ordinary annuity (6%, 10 periods) = ($500, 000 x 5%) x 7. 3601 $184, 002 Present Value (PV of principal) = $500, 000 (6%, 10 periods) = $500, 000 x 0. 5584 $279, 200 BOND PRICE = $463, 202 © 2006 By Default!
Slide 22 A Free sample background from www. awesomebackgrounds. com Record the issue of bonds Face Value: Sold: Issued $500, 000 $463, 202 $36, 798 discount. Date: January 1, 2012 Dr. Cash 463, 202 Dr. Discount on Bonds Payable 36, 798 Cr. Bonds payable 500, 000 © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Effective interest method Amortize premium/discount © 2006 By Default! Slide 23
A Free sample background from www. awesomebackgrounds. com Reporting: Statement Presentation Slide 24 JJ Corporation Partial Balance Sheet December 31, 2012 Current Liabilities: Interest Payable LT Liabilities Bonds Payable Less: Discount on Bonds Payable $25, 000 $500, 000 (31, 046) $468, 954 Discount on bonds Payable 36, 798 – (2, 792+2, 960) = 31, 046 © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Determining the Price: Slide 25 On January 1, 2011, Masterwear Industries issued $700, 000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup. © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Determining the Price: Slide 26 On January 1, 2011, Masterwear Industries issued $700, 000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup. Present value of an ordinary annuity of $1: n=6, i=7% present value of $1: n=6, i=7% Because interest is paid semiannually, the present value calculations use: (a) the semiannual stated rate (6%), (b) the semiannual market rate (7%), and (c) 6 (3 x 2) semi-annual © 2006 By Default!
Slide 27 A Free sample background from www. awesomebackgrounds. com Bond Amortization Schedule Here is a bond amortization schedule showing the cash interest, effective interest, discount amortization, and the carrying value of the bonds. © 2006 By Default! $666, 633 + $4, 664 = $671, 297
A Free sample background from www. awesomebackgrounds. com LESSON 1: CHAPTER 14 PART II ü BONDS ISSUE COST ü BONDS ISSUED INBETWEEN DATES ü RETIREMENT OF BONDS ü CONVERSION OF BONDS © 2006 By Default! Slide 28
A Free sample background from www. awesomebackgrounds. com Bond Issue Costs What is Bond issue Costs? – According to FASB: (APB 21) • Debt issue costs are recorded separately as an asset. • Amortized over the term to maturity using straight line method. © 2006 By Default! Slide 29
Slide 30 A Free sample background from www. awesomebackgrounds. com U. S. GAAP vs. IFRS Debt issue costs (called transaction costs under IFRS) are accounted for differently by U. S. GAAP and IFRS. • Debt issue costs are recorded separately as an asset. • Amortized over the term to maturity. © 2006 By Default! • “Transaction costs” reduce the recorded amount of the debt. • The cost of these services reduces the net cash the issuing company receives and the amount recorded for the debt.
A Free sample background from www. awesomebackgrounds. com BONDS ISSUED BETWEEN INTEREST DATES Bonds issued between interest days n Interest accrues from the date of the bonds n Buyer is required to pay accrued interest n Accrued interest is reported as interest payable (current liability) Year-end Between interest dates © 2006 By Default! Slide 31
Slide 32 A Free sample background from www. awesomebackgrounds. com Issued between interest date: April 30 th issued $100, 000 6% bonds on May 31 April 30 Bond Date May 31 Issue Date Investor pays face value + Accrued interest $100, 000 + $500 ($100, 000 x 6% x 1/12) © 2006 By Default! Oct 31 Interest Payment Date Corp. pays full 6 months’ of interest of $3, 000
A Free sample background from www. awesomebackgrounds. com Slide 33 Retirement of Bonds: Extinguishment of Debt (Bonds Refinancing)* Ø Bonds retired at Maturity or Early Ø Bonds may be “Called” (Reacquisition) Ø Ø or “Redeemed” retired prior to maturity May be for all outstanding bonds, or a portion *Refinancing or refunding: issuing new bonds and applying the proceeds to the retirement of outstanding bonds/debts before maturity © 2006 By Default!
Early Extinguishment of Debt (FASB 145) A Free sample background from www. awesomebackgrounds. com - Update the relevant accounts: (premium/discount and any issue costs) - Carrying Value (book value) Debt retired before maturity may result in an gain or loss on extinguishment. Cash Proceeds – Book Value = Gain or Loss The FASB requires that the gain or loss be classified in the Income Statement as(OTHER gains/losses) unusual/infrequent Debt retired at maturity results in NO gain/losses © 2006 By Default! Slide 34
A Free sample background from www. awesomebackgrounds. com Convertible Bonds n Sell the bonds at higher price (lower interest rate) n In-Direct way of selling stock n Medium of exchange in business combination n …. © 2006 By Default! Slide 35
A Free sample background from www. awesomebackgrounds. com Convertible Bonds n exchanging bond -> common stock (1) updates interest expense and (2) amortization of discount or premium to the date of conversion. (3) The bonds are reduced and shares of common stock are increased. © 2006 By Default! Slide 36
A Free sample background from www. awesomebackgrounds. com Convertible bonds: Slide 37 Option of converting the bonds into common stock. The conversion may be recorded under either Book value method (more common) or Market value method Professor Vedd © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Slide 38 CONVERSION OF BONDS: BOOK VALUE METHOD NO gain or loss is recognized STEPS: 1. Update the accrued interest up to the conversion date, 2. Amortize the bond discount or premium up to the conversion date, 3. Amortize the bond issue costs up to the conversion date, and 4. Record any difference as additional paid-in capital. (stocks are with par value) n © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Slide 39 CONVERSION OF BONDS MARKET VALUE METHOD recognized gain or loss. : using Market Value Method n At conversion: n – The difference between the market value of the stock – & the book value of the bonds =gain or loss on CONVERSION. © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Slide 40 Bonds with Detachable Warrants n Attraction for Investor n Bonds are issued with an instrument -added value i. e. warrant n Stock warrants: – option to purchase: – a specified number of COMMON shares – specified option price per share – within a stated period. © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com STOCK WARRANTS n Bonds issued in conjunction with stock warrants. n Bonds/warrants issued as elements of a single security n Investors can trade the stock warrants separately n Issuer is required to allocate the joint issuance price between the two instruments © 2006 By Default! Slide 41
A Free sample background from www. awesomebackgrounds. com Reporting Debt at Fair Value SFAS No 159 n Not Required: but option to value (some or all) liabilities at Fair Value n If option is elected: – Increase/decrease in fair value is reported as a unrealized loss/gain in the income statement © 2006 By Default! Slide 42
A Free sample background from www. awesomebackgrounds. com Slide 43 FAIR VALUE REPORTING (SFAS No 157) To determine FV : present value of the remaining cash flows discounted at the current interest rate. At December 31, 18 of the original 20 payments remain. Professor Vedd © 2006 By Default!
Calculating FV A Free sample background from www. awesomebackgrounds. com Slide 44 To determine FV : present value of the remaining cash flows discounted at the current interest rate. REMAINING 18 PERIODS If the current interest rate is 9% (4. 5% semi-annually), Present Values Interest $ 32, 000¥ x 12. 15999*=$389, 120 Principal $800, 000 x 0. 45280† = 362, 240 Present value of the bonds $751, 360 ¥ (8% / 2) x $800, 000 * Present value of an ordinary annuity of $1: n = 18, i = 4. 5%. (Table 4) † Present value of $1: n = 18, i = 4. 5%. © 2006 By Default!
Slide 45 A Free sample background from www. awesomebackgrounds. com Reporting FV To increase the book value of $706, 483 to Fair Value $751, 360 entry: Unrealized holding loss 44, 877 Fair value adjustment ($751, 360 – $706, 483) © 2006 By Default! 44, 877
Slide 46 A Free sample background from www. awesomebackgrounds. com BALANCE SHEET PRESENTATION DECEMBER 31 LONG TERM LIABILITIES: BONDS PAYABLE LESS DISCOUNTS ON BONDS CARRYING VALUE AT DEC. Fair value adjustment ($751, 360 – $706, 483) $800, 000 (93, 517) $706, 483 44, 877 ADJUSTED CARRYING VALUE AT FV $751, 360 © 2006 By Default!
A Free sample background from www. awesomebackgrounds. com Debt Financing: Chapter 14: Summary Debt financing Accounting/recording: BONDS Introduction Various financing Introduction: Bonds & various types of bonds Bonds payable issued at discount/premium… Bonds Issued between interest dates Retirement/Redemption of bonds Convertible bonds Bonds refinancing Stock Warrants Fair Value Reporting Professor Vedd © 2006 By Default! Slide 47
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