A bond certificate is the bond document that each bondholder receives.
When a company issues its bonds, it specified two types of cash payment in the bond contract:
Principal. This amount is usually a single payment that is made when the bond matures. It is also called the par value or face value. For most individual bonds, the par value is $1,000, but it can be any amount.
Cash interest payments. These payments, which represent an annuity, are computed by multiplying the principal amount times the interest rate stated in the bond contract. This interest is called the contract, stated, or coupon rate of interest. The bond contract specifies whether the interest payments are made quarterly, semiannually, or annually. When you are asked to work problems in which interest payments are made more frequently than once a year, you must adjust both the periodic interest rate and the number of periods. For example, a $1,000 (face value) bond with an annual interest rate of 6 percent and a life of 10 years would pay interest of $30 ($1,000 × 6% × 1/2) for 20 periods (every six months for 10 years, or 10 × 2).
Neither the issuing company nor the underwriter determines the price at which the bonds sell. Instead, the market determines the price using the present value concepts introduced in the last chapter. To determine the present value of the bond, you compute the present value of the principal (a single payment) and the present value of the interest payments (an annuity) and add the two amounts.
Creditors demand a certain rate of interest to compensate them for the risks related to bonds, called the market interest rate (also known as the yield or effective-interest rate ). Because the market rate is the interest rate on debt when it is incurred, it is the rate that should be used in computing the present value of a bond.
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Chapter 10Reporting and interpreting BondsMcGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.Characteristics of Bonds PayableTwo types of cash payment in the bond contract:1. Principal.2. Cash interest payments. Bond TermsPrincipal, par value and face valueContract, stated, or coupon rate of interestMarket, yield, or effective-interest rateReporting Bond Transactions==Bonds Issued at Par On January 1, 2014, AT&T issues $100,000 in bonds having 10% annual stated rate of interest. The bonds mature in 2 years and interest is paid semiannually. The market rate is 10% annually.This bond is issued at a par.==Bonds Issued at ParHere is the entry made every six months to record the interest payment.Here is the entry to record the maturity of the bonds.Bonds Issued at Discount On January 1, 2014, AT&T issues $100,000 in bonds having a 10% annual stated rate of interest. The bonds mature in 2 years (Dec. 31, 2015) and interest is paid semiannually. The annual market rate of interest is 12%.This bond is issued at a discount.>Bonds Issued at PremiumThe issue price of a bond is composed of the present value of two items: Principal (a single amount)Interest (an annuity)First, compute the present value of the principal.Market rate of 8% ÷ 2 interest periods per year = 4%Bond term of 2 years × 2 periods per year = 4 periodsBonds Issued at PremiumNow, compute the present value of the interest.The issue price of a bond is composed of the present value of two items: Principal (a single amount)Interest (an annuity)Market rate of 8% ÷ 2 interest periods per year = 4%Bond term of 2 years × 2 periods per year = 4 periodsBonds Issued at PremiumFinally, determine the issue price of the bond.The $103,630 is greater than the face amount of $100,000, so the bonds are issued at a premium of $3,630. The issue price of a bond is composed of the present value of two items: Principal (a single amount)Interest (an annuity)Bonds Issued at PremiumThe premium will be amortized over the 2-year life of the bonds.Reporting Interest Expense: Straight-line AmortizationAn amortization table illustrates the interest payment, interest expense, premium amortization, unamortized premium balance, and the carrying value of the bond for each interest payment period over the life of the bond.Reporting Interest Expense: Straight-line AmortizationHere is the journal entry to record the payment of interest and the premium amortization every six months using the straight-line amortization method.*Reporting Interest Expense: Effective-interest AmortizationNotice that for the effective-interest method, the amount of interest expense and premium amortization varies each period, unlike under the straight-line method where these were the same each period. Reporting Interest Expense: Effective-interest AmortizationHere is the journal entry to record the payment of interest and the premium amortization for the six months ending on June 30, 2014.Early Retirement of DebtOccasionally, the issuing company will call (repay early) some or all of its bonds.Gains/losses are calculated by comparing the bond call amount with the book value of the bond.Book Value > Retirement Price = GainBook Value < Retirement Price = LossEnd of Chapter 10
