ACCT1511 QUIZ 1
Accounting for Bonds
The rate of return required by the market might fluctuate daily: hence it is usual for bonds not to be issue at face value. Bonds will only be issued at face value if the rate demanded by bond holders (the market rate) is the same as the rate shown on the bonds (called the coupon rate). You should remember that, regardless of what the bond holder pay for the bond, the will receive the face value on maturity; and the interest payment the bond holder receive will be the coupon rate on the bond multiplied by the face value (regardless of the price paid for the bond). In other words, the amount the bond holders receive on maturity and the interest payment they receive will not change, regardless of what is paid for the bonds. If the market rate required by the bond holder is higher than the than the coupon rate of the bonds, the issue price must be reduced to the price at which the cash flows to the bond holder – in form of the periodic interest payments and the final payment of the principal – represent a rate of return equivalent to that required by the market. That is, the debentures will be issued at a discount. The bond discount is a reflection that the coupon payments are lower than the required payments that would have been required if the market interest rate had been used.
Because the bonds’ coupon payments are fixed, receiving less money for those coupon payments than the face value of the bond, as in the case of a discount, has the effect of increasing the interest expense. The amortisation of the discount will increase the carrying value of the liability until maturity, at which point, the liability is valued at the face value of the bonds. The amortisation of the discount also increases the period’s interest expense so that it is lower than the coupon payments.
The opposite logic applies to bond premiums where the coupon rate is higher than the market rate.
Carrying Amount of Bonds
Bond Premium
Carrying
The rate of return required by the market might fluctuate daily: hence it is usual for bonds not to be issue at face value. Bonds will only be issued at face value if the rate demanded by bond holders (the market rate) is the same as the rate shown on the bonds (called the coupon rate). You should remember that, regardless of what the bond holder pay for the bond, the will receive the face value on maturity; and the interest payment the bond holder receive will be the coupon rate on the bond multiplied by the face value (regardless of the price paid for the bond). In other words, the amount the bond holders receive on maturity and the interest payment they receive will not change, regardless of what is paid for the bonds. If the market rate required by the bond holder is higher than the than the coupon rate of the bonds, the issue price must be reduced to the price at which the cash flows to the bond holder – in form of the periodic interest payments and the final payment of the principal – represent a rate of return equivalent to that required by the market. That is, the debentures will be issued at a discount. The bond discount is a reflection that the coupon payments are lower than the required payments that would have been required if the market interest rate had been used.
Because the bonds’ coupon payments are fixed, receiving less money for those coupon payments than the face value of the bond, as in the case of a discount, has the effect of increasing the interest expense. The amortisation of the discount will increase the carrying value of the liability until maturity, at which point, the liability is valued at the face value of the bonds. The amortisation of the discount also increases the period’s interest expense so that it is lower than the coupon payments.
The opposite logic applies to bond premiums where the coupon rate is higher than the market rate.
Carrying Amount of Bonds
Bond Premium
Carrying