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1 1 Adeng Pustikaningsih, M.Si. Dosen Jurusan Pendidikan Akuntansi Fakultas Ekonomi Universitas Negeri Yogyakarta CP: adengpustikaningsih@uny.ac.id 1

2 2 15 Bonds Payable and Investments in Bonds 2

3 3 After studying this chapter, you should be able to: 1. Compute the potential impact of longterm borrowing on earnings per share. 2. Describe the characteristics, terminology, and pricing of bonds payable. 3. Journalize entries for bonds payable. 3

4 4 After studying this chapter, you should be able to: 4. Describe and illustrate the payment and redemption of bonds payable. 5. Journalize entries for the purchase, interest, discount and premium amortization, and sale of bond investments. 6. Prepare a corporation balance sheet. 4

5 Objective 1 Compute the potential impact of long-term borrowing on the earnings per share of a corporation. 5

6 6 Financing Corporations 15-1 A bond is simply a form of an interest-bearing note. Like a note, a bond requires periodic interest payments, and the face amount must be repaid at the maturity date. 6

7 Plan 1 Plan 2 Plan 3 Issued 12% bonds Rp2 billion Issued 9% preferred stock, Rp50,000 par value -- Rp2 billion Rp1 billion Issued common stock, Rp10,000 par value Rp4 billion Rp2 billion Rp1 billion Rp4 billion Rp4 billion Rp4 billion 67

8 8 Click to Effect edit of Alternative Master title style Financing Plans Rp800,000,000 Earnings

9 9 Click to Effect edit of Alternative Master title style Financing Plans Rp440,000,000 Earnings

10 Example Exercise 15-1 PT Gilang., is considering the following alternative plans for financing their company (in 000 Rp): Plan I Plan II Issue 10% Bonds (at face) Rp2,000,000 Issue Rp10 Common Stock Rp3,000,000 Rp1,000,000 Income tax is estimated at 30% of income. Determine the earnings per share of common stock under the two alternative financing plans, assuming income before bond interest and income tax is Rp750,000,

11 11 Follow My Example 15-1 Earnings before bond interest and income tax Bond interest Balance Income tax (750,000 x 30%) Net income Dividend on preferred stock Earnings available for common stock Number of common shares Earnings per share on common stock (in 000 Rp) Plan I Rp750,000 0 Rp750, ,000 Rp525,000 0 Rp525,000 /300,000 Rp1,750 For Practice: PE 15-1A, PE 15-1B 15-1 (in 000 Rp) Plan II Rp750,000 (2,000,000 x 10%) 200,000 Rp550,000 (550,000 x 30%) 165,000 Rp385,000 0 Rp385,000 /100,000 Rp3,

12 Objective 2 Describe the characteristics, terminology, and pricing of bonds payable. 12

13 13 Bonds Payable 15-2 A corporation that issues bonds enters into a contract (called a bond indenture or trust indenture) with the bondholders. Usually, the face value of each bond, called the principal, is Rp1,000,000 or a multiple of Rp1,000,000. Interest on bonds may be payable annually, semiannually, or quarterly. Most pay interest semiannually. 13

14 14 When all bonds of an issue mature at the same time, they are called term bonds. If the maturity dates are spread over several dates, they are called serial bonds. Bonds that may be exchanged for other securities are called convertible bonds

15 15 Bonds that a corporation reserves the right to redeem before their maturity are called callable bonds. Bonds issued on the basis of the general credit of the corporation are debenture bonds

16 16 Pricing of Bonds Payable When a corporation issues bonds, the price that buyers are willing to pay depends upon three factors: 1. The face amount of the bonds, which is the amount due at the maturity date. 2. The periodic interest to be paid on the bonds. This is called the contract rate or the coupon rate. 3. The market or effective rate of interest

17 The market or effective rate of interest is determined by transactions between buyers and sellers of similar bonds. The market rate of interest is affected by a variety of factors, including: 1. investors assessment of current economic conditions, and 2. future expectations. 17

18 MARKET RATE = CONTRACT RATE Selling price of bond = Rp1,000,000 Rp1,000,000 10% payable annually If the contract rate equals the market rate of interest, the bonds will sell at their face amount

19 MARKET RATE > CONTRACT RATE Selling price of bond < Rp1,000,000 Rp1,000,000 10% payable annually Discount If the market rate is higher than the contract rate, the bonds will sell at a discount

20 MARKET < CONTRACT RATE Selling price of bond > Rp1,000,000 Rp1,000,000 10% payable annually + Premium If the market rate is lower than the contract rate, the bonds will sell at a premium

21 21 Time Value of Money 15-2 The time value of money concept recognizes that an amount of cash to be received today is worth more than the same amount of cash to be received in the future. 21

22 22 Present Value of the Face Amount of Bonds A Rp1,000,000, 10% bond is purchased. It pays interest annually and will mature in two years Rp1,000, % payable annually Today End of Year 1 End of Year 2 Rp826,450 Rp1,000,000 x

23 23 Example Exercise Using Exhibit 3 in your test, what is the present value of Rp4,000,000 to be received in 5 years, if the market rate of interest is 10% compounded annually? Follow My Example 15-2 Rp4,000,000 x.62092* = Rp2,483,680 *Present value of Rp1 for 5 periods at 10% For Practice: PE 15-2A. PE 15-2B 23 22

24 24 Present Value of the Periodic Bond Interest Payments 15-2 Rp100,000 Interest payment Rp100,000 Interest payment Today End of Year 1 End of Year 2 Rp90,910 Rp100,000 x Rp82,64 0 Rp173,550 Rp100,000 x Present value, at 10%, of Rp100,000 interest payments to be received each year for 2 years (rounded) 23 24

25 25 Present Value of 2-Year, 10% Bond 15-2 Present value of face value of Rp1,000,000 due in 2 years at 10% compounded annually: Rp1,000,000 x (Exhibit 3: n = 2, i = 10%)(Slide 21) Rp 826,450 Present value of 2 annual interest payments of 10% compounded annually: Rp100,000 x (Exhibit 4: n = 2, i = 10%) (Slide 23) 173,550 Total present value of bond Rp1,000,

26 Example Exercise 15-3 Calculate the present value of a Rp20,000,000, 5%, 5-year bond that pays Rp1,000,000 (Rp20,000,000 x 5%) interest annually, if the market rate of interest is 5%. Use Exhibits 3 and 4 for computing present values

27 Follow My Example 15-3 Present value of face value of Rp20,000,000 due in 5 years at 5% compounded annually: Rp20,000,000 x (present value factor of Rp1 for 5 periods at 5%) Present value of 5 annual interest payments of Rp1,000,000 at 5% interest compounded annually: Rp1,000,000 x (present value of annuity of Rp1 for 5 periods at 5%). *Rounded to the nearest rupiah For Practice: PE 15-3A, PE 15-3B Rp15,671,000* 4,329,000* $20,000,

28 Objective 3 Journalize entries for bonds payable. 28

29 29 Bonds Issued at Face Amount 15-3 On January 1, 2007, a corporation issues for cash Rp100,000,000 of 12%, fiveyear bonds; interest payable semiannually. The market rate of interest is 12%. 29

30 Present value of face amount of Rp100,000,000 due in 5 years at 12% compounded annually: Rp100,000,000 x (Exhibit 3: n = 10, i = 6%) Rp 55,840,000 Present value of 10 interest payments of Rp6,000,000 at 12% compounded semiannually: Rp6,000,000 x (Exhibit 4: n = 10; i = 6%) Total present value of bonds 44,160,000* Rp100,000,000 *Because the present value tables are rounded to five decimal places, minor rounding differences may appear in this illustration

31 On January 1, 2007, a corporation issues for cash Rp100,000,000 of 12%, five-year bonds; interest payable semiannual. The market rate of interest is 12% Jan. 1 Cash Bonds Payable Issued Rp100,000,000 bonds payable at face amount

32 On June 30, an interest payment of Rp6,000,000 is made (Rp100,000,000 x.12 x 6/12). June 30 Interest Expense Cash Paid six months interest on bonds

33 The bond matured on December 31, At this time, the corporation paid the face amount to the bondholder Dec. 31 Bonds Payable Cash Paid bond principal at maturity date

34 34 Bonds Issued at a Discount 15-3 Assume that the market rate of interest is 13% on the Rp100,000,000 bonds rather than 12%. What would be the present value of these bonds? 34

35 35 Present value of face amount of Rp100,000,000 due in 5 years at 13% compounded semiannually: Rp100,000,000 x Rp53,273, Present value of 10 interest payments of Rp6,000,000, at 13% compounded semiannually: Rp6,000,000 x (present value of annuity of Rp1 for 10 periods at 6%) Total present value of bonds 43,133,000 Rp96,406,

36 On January 1, 2007, the firm issued Rp100,000,000 bonds for Rp96,406,000 (a discount of Rp3,594,000) Jan. 1 Cash Discount on Bonds Payable Bonds Payable Issued Rp100,000,000 bonds at discount

37 Example Exercise 15-4 On the first day of the fiscal year, a company issues a Rp1,000,000,000, 6%, 5-year bond that pays semi-annual interest of Rp30,000,000 (Rp1,000,000,000 x 6% x ½), receiving cash of Rp845,562,000. Journalize the entry to record the issuance of the bonds. Follow My Example 15-4 Cash 845,562,000 Discount on Bonds Payable 154,438,000 Bonds Payable 1,000,000,000 For Practice: PE 15-4A, PE 15-4B 36 37

38 38 Amortizing a Bond Discount 15-3 There are two methods of amortizing a bond discount: 1) The straight-line method and 2) The effective interest rate method, often called the interest method. Both methods amortize the same total amount of discount over the life of the bonds. 38

39 39 Amortizing a Bond Discount 15-3 On June 30, 2007, six-months interest is paid and the bond discount is amortized (Rp3,594,000 x 1/10) using the straight-line method June 30 Interest Expense Discount on Bonds Payable Cash Paid semiannual interest and amortized 1/10 of bond discount

40 Example Exercise 15-5 Using the bond from Example Exercise 15-4, journalize the first interest payment and the amortization of the related bond discount. Click on this button to go to Example Exercise To return to this slide, type 39 and press Enter. Follow My Example 15-5 Interest Expense 45,443,800 Discount on Bonds Payable 15,443,800 Cash 30,000,000 Paid interest and amortized the bond discount (Rp154,438,000 10). For Practice: PE 15-5A, PE 15-5B 39 40

41 41 Bonds Issued at a Premium 15-3 If the market rate of interest is 11% and the contract rate is 12%, on the five year, Rp100,000,000 bonds, the bonds will sell for Rp103,769,

42 42 Present value of face amount of Rp100,000,000 due in 5 years at 11% compounded semiannually: Rp100,000,000 x (Exhibit 3: n =10, i = 5½%) Rp 58,543, Present value of 10 interest payments of Rp6,000,000 at 11% compounded semiannually: Rp6,000,000 x (Exhibit 4: n = 10, i = 5½%) Total present value of bonds 45,226,000 Rp103,769,

43 43 Issued Rp100,000,000 of bonds for Rp103,769,000 (a premium of Rp3,769,000). The entry to record this information is as follows: 2007 Jan. 1 Cash Bonds Payable Premium on Bonds Payable Issued Rp100,000,000 bonds at a premium

44 Example Exercise 15-6 A company issues a Rp2,000,000,000, 12%, 5-year bond that pays semiannual interest of Rp120,000,000 (Rp2,000,000,000 x 12% x ½), receiving cash of Rp2,154,435,000. Journalize the bond issuance. Follow My Example 15-6 Cash 2,154,435,000 Premium on Bonds Payable 154,438,000 Bonds Payable 2,000,000,000 For Practice: PE 15-6A, PE 15-6B 44 43

45 Amortizing a Bond Premium 15-3 On June 30, 2007,

premium. The firm uses straight-line amortization.

Bonds Payable 376 900 Cash 6 000 000 Paid semiannual

45 45 Amortizing a Bond Premium 15-3 On June 30, 2007, paid the semiannual interest and amortized the premium. The firm uses straight-line amortization June 30 Interest Expense Premium on Bonds Payable Cash Paid semiannual interest and amortized 1/10 of bond prem. Rp3,769,000 x 1/

46 Example Exercise 15-7 Using the bond from Example Exercise 15-6 (Slide 43), journalize the first interest payment and the amortization of the related bond premium. Follow My Example 15-7 Interest Expense 104,556,000 Premium on Bonds Payable 15,444,000 Bonds Payable 120,000,000 Paid interest and amortize the bond premium (Rp154,435,000/10). For Practice: PE 15-7A, PE 15-7B 45 46

47 47 Zero-Coupon Bonds 15-3 Zero-coupon bonds do not provide for interest payments. Only the face amount is paid at maturity. Assume that the market rate is 13% at date of issue. Present value of Rp100,000,000 due in 5 years at 13% compounded semiannually: Rp100,000,000 x (PV of Rp1 for 10 periods at 6½%) = Rp53,273,

48 On January 1, 2007, issue 5-year, Rp100,000,000 zero-coupon bonds when the market rate of interest is 13% Jan. 1 Cash Discount on Bonds Payable Bonds Payable Issued Rp100,000,000 zero-coupon bonds

49 Objective 4 Describe and illustrate the payment and redemption of bonds payable. 49

50 Since the payment of bonds normally involves a large amount of cash, a bond indenture may require that cash be periodically transferred into a special cash fund, called a sinking fund, over the life of the bond issue. 50

51 51 Bond Redemption 15-4 A corporation may call or redeem bonds before they mature. Callable bonds can be redeemed by the issuing corporation within the period of time and the price stated in the bond indenture. Normally, the call price is above the face value. 51

52 52 On June 30, a corporation has a bond issue of Rp100,000,000 outstanding on which there is an unamortized premium of Rp4,000,000. The corporation purchases one-fourth of the bonds for Rp24,000, June 30 Bonds Payable Premium on Bonds Payable Cash Gain on Redemption of Bonds Retired bonds for $24,

53 Instead, assume that on June 30 the corporation calls all of the bonds, paying Rp105,000, June 30 Bonds Payable Premium on Bonds Payable Loss on Redemption of Bonds Cash Redeemed Rp100,000,000 bonds for Rp105,000,

54 Example Exercise 15-8 A Rp500,000,000 bond issue on which there is an unamortized discount of Rp40,000,000 is redeemed for Rp475,000,000. Journalize the redemption of the bonds. Follow My Example 15-8 Bonds Payable 500,000,000 Loss on Redemption of Bonds 15,000,000 Discount on Bonds Payable 40,000,000 Cash 475,000,000 For Practice: PE 15-8A, PE 15-8B 54 53

55 Objective 5 Journalize entries for the purchase, interest, discount, and premium amortization, and sale of bond investments. 55

56 56 Accounting for Bond Investments 15-5 Bonds may be purchased either directly from the issuing corporation or through an organized bond exchange. Prices for bonds are quoted as a percentage of the face amount. 56

57 On April 2, 2007, an investor purchases a Rp1,000,000 PT Ludiro Madu bond at 102 plus a brokerage fee of Rp5,300 and accrued interest of Rp10, Apr. 2 Investment in PT Ludiro Madu. Bonds Interest Revenue Cash Invested in a PT Ludiro Madu bond

58 On April 2, 2007, an investor purchases a Rp1,000,000 PT Ludiro Madu bond at 102 plus a brokerage fee of Rp5,300 and accrued interest of RP10, Apr. 2 Investment in PT Ludiro Madu Bonds Interest Revenue Cash Invested in a PT Ludiro Madu bond. Note that the brokerage fee is added to the cost of the investment

59 59 Extended Illustration for Cahaya PT 15-5 On July 1, 2007, PT Cahaya. purchases Rp50,000,000 of 8% bonds of PT Ditho due in 8 3/4 years. The effective interest rate is 11%. The purchase price is Rp41,706,000 plus interest of Rp1,000,000 accrued from April 1, 2007 (Rp50,000,000 x 8% x 3/12). 59

60 The entry to record the investment is as follows: 2007 July 1 Investment in PT Ditho. Bonds Interest Revenue Cash Purchased investment in bonds, plus accrued interest

61 PT Cahaya received semiannual interest for April 1 to October 1 (Rp50,000,000 x 8% x 6/12). Oct. 1 Cash Interest Revenue Received semiannual interest for April 1 to October

62 Adjusting entry for interest accrued from October 1 to December 31 (Rp50,000,000 x 8% x 3/12). Dec. 31 Interest Receivable Interest Revenue Adjusting entry for interest accrued from October 1 to December

63 63 Adjusting entry for amortization of discount for July 1 to December 31: (Rp50,000,000 Rp41,706,000)/105 = Rp79,000 (rounded) x 6 months Investment in PT Ditho Bonds Interest Revenue Adjusting entry for amortization of discount for July 1 to December

64 The effect of these entries on Interest Revenue is as follows: July 1 1,000,000 Interest Revenue Oct. 1 2,000,000 Dec. 31 Adj.1,000, Adj. 474,000 Adj. Bal. 2,474,

65 65 Accounting for Bond Investments Sale 15-5 PT Ditho bonds are sold for Rp47,350,000 plus accrued interest on June 30, The carrying amount of the bond as of January 1, 2014 is Rp47,868,000 [Rp41,706,000 + (Rp79,000 per month x 78 months)]. 65

66 It has been six months since the last amortization entry, so amortization for this period is recorded (6 months) June 30 Investment in PT Ditho Bonds Interest Revenue Amortized discount for current year

67 The next slide shows the Investment in PT Ditho. Bonds account after all amortization entries have been made, including the June 30, 2014 adjusting entry. 67

68 68 Investment in PT Ditho Bonds 2007 July 1 41,706,000 Dec , Dec , Dec , Dec , Dec , Dec , Dec , June ,000 48,342,

69 69 This investment is sold on June 30, 2014 for Rp47,350,000 plus accrued interest of $1,000 (Rp50,000,000 x 8% x 3/12). 30 Cash Loss on Sale of Investments Interest Revenue Investment in PT Ditho Bonds Received interest and proceeds from sale of bonds

70 Example Exercise 15-9 On October 1, 2008 PT Gema Persada purchases Rp10,000,000 of 6% bonds of PT Gaung Negeri due in 9¼ years. The bonds were purchased at a price of Rp8,341,000 plus interest of Rp150,000 (Rp10,000,000 x 6% x 3/12) accrued from July 1, 2008, the date of the last semiannual interest payment. a. Journalize the purchase of the bonds plus accrued interest. b. Journalize the entry to record the amortization of the discount on December

71 15-5 Follow My Example 15-9 a. b. 2008 Oct. 1 2008 Dec. 1 Investment in PT Gaung Negeri.

71 Follow My Example 15-9 a. b Oct Dec. 1 Investment in PT Gaung Negeri. Bonds 8,341,000 Interest Revenue 150,000 Cash 8,491,000 Investment in PT Gaung Negeri Bonds 42,000* Interest Revenue 42,000 *[(Rp10,000,000 Rp8,341,000)/111 months] x 3 months For Practice: PE 15-9A, PE 15-9B 71 70

72 Objective 6 Prepare a corporation balance sheet. 72

73 73 Click Balance to edit Sheet Master of a title style Corporation 15-6 (Continued) 73 72

74 74 Click Balance to edit Sheet Master of a title style Corporation 15-6 (Concluded) 74 73

75 75 Held-to-Maturity Securities 15-6 Investments in bonds or other debt securities that management intends to hold to their maturity are called held-to-maturity securities. 75

76 76 Balance Sheet Presentation of Bond Investments Such securities are classified as long-term investments under the caption Investments. These investments are reported at their cost less any amortized premium or plus any amortized discount. The market (fair) value of the bond investment should be disclosed, either on the face of the balance sheet or in an accompanying note

77 77 Financial Analysis and Interpretation 15-6 Some corporations have a high ratio of debt to stockholders equity. For such corporations, analysts often assess the relative risk of the debtholders in terms of the number of times the interest charges are earned during the year. 77

78 78 Number of Times the Interest Charges Earned 15-6 To illustrate, assume the following data: Interest expense Rp 36,883,000,000 Income before income tax 174,315,000,000 Income before income tax + Interest expense Interest expense Rp174,315,000,000 + Rp36,883,000,000 Rp36,883,000,000 (Continued) 78 77

79 The number of times interest charges are earned is This ratio indicates that the debtholders have adequate protection against a potential drop in earnings jeopardizing their receipt of interest payments. A full analysis should involve a comparison with industry averages. 79

Click to edit Master title style

Click to edit Master title style 1 Adeng Pustikaningsih, M.Si. Dosen Jurusan Pendidikan Akuntansi Fakultas Ekonomi Universitas Negeri Yogyakarta CP: 08 222 180 1695 Email : adengpustikaningsih@uny.ac.id 1 2 Corporations: 13 Organization,