Bond Characteristics and Terminology (slide 1 of 2)
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A bond is a form of an interest-bearing note. Like a note, a bond requires periodic interest payments, with the face amount to be repaid at the maturity date. The face amount of each bond, called the principal, is usually $1,000 or a multiple of $1,000. The principal must be repaid on the dates the bonds mature. The interest on bonds may be payable annually, semiannually, or quarterly. o
Most bonds pay interest semiannually.
The underlying contract between the company issuing bonds and the bondholders is called a bond indenture.
• The face amount and the interest rate on the bonds • •
are identified in the bond indenture. The interest rate to be paid on the face amount of the bond is called the contract rate or coupon rate. The market rate of interest, sometimes called the effective rate of interest, is the rate determined from sales and purchases of similar bonds.
• If the market rate equals the contract rate, bonds will •
sell at the face amount. If the market rate is greater than the contract rate, the bonds will sell for less than their face value. The face amount of the bonds less the selling price is called a discount. If the market rate is less than the contract rate, the bonds will sell for more than their face value. The selling price of the bonds less the face amount is called a premium.
Because the contract rate of interest is less than the market rate of interest, the bonds will sell at less than their face amount. Assuming the bonds sell for $96,406, the entry to record the issuance of the bonds is as follows:
• Every period, a portion of the bond discount must be reduced and added to interest expense to reflect the passage of time. This process, called amortization, increases the contract rate of interest on a bond to the market rate of interest that existed on the date the bonds was issued.
Because the contract rate of interest is more than the market rate of interest, the bonds will sell for more than their face amount. Assuming the bonds sell for $103,769, the entry to record the issuance of the bonds is as follows:
Premium on Bonds Payable has a normal credit balance. It is added to Bonds Payable to determine the carrying amount (or book value) of the bonds payable. Thus, the carrying amount of the bonds payable is $103,769 ($100,000 + $3,769).
• Like bond discounts, a bond premium must be amortized over the life of the bond. The amortization of a bond premium decreases the contract rate of interest on a bond to the market rate of interest that existed on the date the bonds were issued.
• A corporation may redeem or call bonds before they mature. o
This is often done when the market rate of interest declines below the contract rate of interest. A corporation usually redeems its bonds at a price different from the carrying amount (or book value) of the bonds. A gain or loss may be realized on a bond redemption and are reported in the Other income (loss) section of the income statement.
Bonds payable and notes payable are reported as liabilities on the balance sheet. o
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Any portion of the bonds or notes that is due within one year is reported as a current liability. Any remaining bonds or notes are reported as a long-term liability.
Any unamortized premium is reported as an addition to the face amount of the bonds. Any unamortized discount is reported as a deduction from the face amount of the bonds. A description of the bonds and notes should also be reported on the face of the financial statements or in the accompanying notes.