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Welcome back.
In this module, we're going to continue talking about bonds and long-term debt,
but we're going to increase the level of complexity a little bit.
We're going to talk about issuing bonds between interest dates
with discount or premium.
We're going to talk about repaying bonds early, or early extinguishment of debt.
We'll talk about added complexity that arises from conversion features,
especially when they have beneficial conversion features.
And then we'll conclude the discussion of debt and long-term bonds with a discussion
on modifications and troubled debt restructurings.
So to start, remember you always just address a bond problem step by step.
You're going to take the present value of the payments.
You're going to take into account the accrued interest that's due,
the shortened bond period.
And the effective yield adjusted for issuance costs and discount.
This is building on what we discussed in module one, but
now we're going to take it to the next level.
So let's put it all together.
I'm going back to Padre Pizza, they're issuing $10 million bonds
on 4/01/2016 that mature in eight years on 12/31/2023.
So the bond period actually started on 1/1/2016,
but they were issued on 4/1/2016.
So there's already three months of accrued interest.
The bonds have a stated interest rate of 8%, but
were sold to yield 8.25% plus the accrued interest during the period.
So now because they were sold to yield 8.25%, but
the stated rate is 8%, there's a discount.
The bonds pay interest semi-annually on June 30th and December 31st.
Padre Pizza also incurred $100,000 in debt issuance costs.
So what is the price paid for the bonds?
What's the yield?
Well let's take the present value of the interest for 15 periods, why 15?
We're going to leave off the first period, it's partial, we'll account for
that separately.
So the net present value for 14 periods at the stated rate x 180/360,
because it's a half-year, the interest is paid semi-annually.
Plus the present value of the payment at the end of $10,400,000 paid in
the final period.
That's $10 million of principle repaid,
plus $400,000 of interest in the final period.
We get a total present value coming back to
June 30th at $9,862,227.
So we've only come back as far as June 30th.
Now we need to discount that back to April 1st, the date it was issued.
So we're going to do that by taking the present value, again,
at the same interest rate that it was sold to yield, 8.25%.
We're going to take it times 90/360 because we're
only accounting for 3 months of interest.
And we've discounted that amount to $9,662,969.
Now that accounts for everything except the accrued interest,
and the accrued interest of $200,000 is then included in there as well.
So what do we have?
Well the bonds were sold to yield 8.25% with 3 months of accrued interest.
They were sold on April 1st with 3 months of accrued interest from January 1st.
The amount of cash we received would be the bonds payable amount,
which net of the discount is $9,858,888 plus $200,000.
So we received $10,058,888.
We would record the cash.
We would record accrued interest of $200,000, and bonds payable of $9,858,888.
This is just a convention that we use by the way,
we don't discount that accrued interest typically.
We put it in a separate account, and just account for a short term liability.
Also on April 1st, we have the issuance costs that were accounted for.
Now those issuance costs, again,
go against bonds payable as part of the discount and the bonds payable.
So the yield is 8.43% and this is the calculated
effective yield, again, based upon that discount.
The first interest payment we're going to make, now this is the one on June 30th.
Remember that these were issued April 1st,
there was $200,000 of accrued interest on the bonds.
So we're going to account for that separately.
And the remainder of the payment and the amortization of the discount
will show as interest expense, so there's $205,667.
And here's an amortization table that we've showed, again,
the only difference is that first payment now is a partial payment,
because we paid $400,000, but the bonds only amortize by the amount of $200,000.
What's happened to the other $200,000?
It was directly taken against that accrued interest payable.
So in summary, it does increase the complexity when the bonds are issued
between periods with a discounted premium.
There's a number of conventions that are sometimes used to estimate the amounts for
amortization of discounted premium in that period.
We chose to calculate it precisely by taking the present value
of the interest payments and the present value of the principle, and
then discounting it for an additional half a period.
You will see other methods in pracitce, but
the theory is going to be the same all the time.
That you're going to recognize as part of the payment that you receive from
the bond holders as being effectively, that they have paid you for
the interest that they're going to receive with that first interest payment.
So the first interest payment is only going to partially be attributable
to amortization of the bonds, and the rest of its going to be
attributable to essentially repaying the bond holder for
the interest they prepaid to you when they bought the bonds.
Thank you.
John HeppClinical Assistant Professor of Accountancy
