Chapter 14 Study Guide Solution notes (1)

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Chapter 14 Study Guide Concepts related to bonds Coupon rate (same as stated rate, contract rate, nominal rate): used to calculate interest payment Effective rate (same as market rate and yield): used to calculate PV, and interest expense. Face value (same as Principal) Interest payment = principal*coupon rate, constant over time Interest expense = prior period carrying value of bonds*effective rate Bond issue at discount (coupon rate is lower than market)/ premium (coupon rate is higher than market ) Amortization of bond discount / premium Bond calculations Bond issuance price =PV of face value+ PV of all coupon payments (OA) With coupon rate, effective rate, bond carrying value, calculate: 1. Interest payment for the interest period 2. Interest expense for the interest period 3. Amortization of bond discount / premium 4. New bond carrying value Contingent liabilities: only recognize when it is probably (condition 1) and the amount is estimable (condition 2)
Sample Questions for Ch 14 Bond 1. Calculate bond price An investor purchases a 5-year, \$1,000 par value bond that pays semiannual interest of \$50. If the semiannual market rate of interest is 6%, what is the current market value of the bond? Solution: Multiply interest payment by PV ordinary annuity of \$1 Multiply face value by PV of a single amount \$1 OA \$50 × 7.36009* = \$ 368 FV \$1,000 × 0.55839** = 558 \$ 926 *PVA of \$1: n = 10; i = 6% **PV of \$1: n = 10; i = 6% 2. Calculate interest expense On January 1, 2021, Legion Company sold \$250,000 of 6% ten-year bonds. Interest is payable semiannually on June 30 and December 31. The bonds were sold for \$163,976, priced to yield 12%. Legion records interest at the effective rate. How much should Legion report bond interest expense for the six months ended June 30, 2021 (first payment)? Solution: Interest expense = Prior period bond carrying value * effective interest First interest expense=bond price*effective interest=163,976*6% June 30, 2021 is the first payment date, prior period bond carrying value=bond price=163,976 Effective interest = 12%/2=6% because interest is paid semiannually. 6.0% × \$163,976 = \$9,839
3. Calculate bond liability balance Auerbach Inc. issued 6% bonds on October 1, 2021. The bonds have a maturity date of September 30, 2031 and a face value of \$500 million. The bonds pay interest each March 31 and September 30, beginning March 31, 2022. The effective interest rate established by the market was 8%. Assuming that Auerbach issued the bonds for \$432,050,000, what would the company report for its net bond liability balance after its first interest payment on March 31, 2022? Solution: 1. Bond carrying value 10/1/2022=Bond price= 432,050,000 2. Interest payment=face value*coupon rate=500,000,00*6%/2=15,000,000 3. Interest expense=bond price*market rate= 432,050,000*8%/2=17,282,000 4. Discount amortization=17,282,000-15,000,000=2,282,000 5. Bond carrying value 3/31/2022=Bond carrying value 10/1/2022+2,282,000= 432,050,000+2,282,000= 434,332,000 Effective interest (semi-annual)=8%/2=4% Stated rate (semi-annual)=6%/2=3% Interest payment=face value*stated rate=500,000,000*3%=15,000,000 Date Interest paid Interest expense Discount amortization Bond carrying value 10/1/2021 432,050,000 3/31/2022 15,000,000 17,282,000 2,282,000 434,332,000 Interest expense= Beginning liability of \$432,050,000*effective interest rate 4%=17,282,000 Discount amortization=interest expense-interest paid=17,282,000-15,000,000 Liability balance = Beginning liability of \$432,050,000 + Discount amortization =\$434,332,000