�OVERVIEW OF BONDS�COLUMBIA CORE ACCOUNTING�REVIEW SESSION��ANTHONY LE�
WHAT ARE BONDS?
WHAT ARE BONDS?
Company A
Person B
(Bondholder)
(1) “Issue” a Bond
YEAR: 2018
BOND TERMS
Term to Maturity: 3 Years
Coupon Rate: 5%
Face Value: $1000
Price of the Bond: $900
+ $900 Cash
WHAT ARE BONDS?
Company A
YEAR: 2018
BOND TERMS
Term to Maturity: 3 Years
Coupon Rate: 5%
Face Value: $1000
Price of the Bond: $900
Company A’s Accounting Journal Entry:
Dr Bond Discount 100
Dr Cash 900
Cr Bonds Payable 1000
Why $900 in Cash? That’s what Company A received for
the bond (i.e., they raised $900 in cash).
Why $1000 for Bonds Payable? The “face value” of the
bond is $1000, meaning the company has an obligation
to pay the bondholder $1000 at maturity.
Why $100 for Bond Discount? The discount of the bond
is always the difference between what the person paid (900)
and the obligation the company has to pay (1000). Since
they received less than their obgliation, we say the bond was
sold at a “discount.”
WHAT ARE BONDS?
Company A
Person B
(Bondholder)
(1) Pay a “coupon” payment
YEAR: 2019
BOND TERMS
Term to Maturity: 3 Years
Coupon Rate: 5%
Face Value: $1000
Price of the Bond: $900
- (0.05*1000) = - $50 Cash
WHAT ARE BONDS?
Company A
Person B
(Bondholder)
(1) Pay a “coupon” payment
YEAR: 2020
BOND TERMS
Term to Maturity: 3 Years
Coupon Rate: 5%
Face Value: $1000
Price of the Bond: $900
- $50 Cash
WHAT ARE BONDS?
Company A
Person B
(Bondholder)
YEAR: 2021
BOND TERMS
Term to Maturity: 3 Years
Coupon Rate: 5%
Face Value: $1000
Price of the Bond: $900
- $50 Cash
- $1,000 Cash
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
NOTE: The “price of the bond” will be equal to the present value
of the stream of cash flows that the bond pays out to the
bondholder.
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.07 * 1000 = $70
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
Problem: Not as simple as “adding up all of the cash flows” because of the time value of money: $70 today is not the same as $70 one year from now or $70 two years from now.
So, the price of the bond is not equal to 70 + 70 + 70 + 70 + 1000��Solution: We will “discount” all of the cash flows to express this in “present value” terms (i.e., in terms of Year 0 dollars)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Assume a company XYZ Ltd has issued a bond having a face value of
$1000, carrying an annual coupon rate of 7% and maturing in 4
years. The prevailing market rate of interest (also known as the “annual yield”) is 9%.
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$70�(coupon payment 4)
(1) -$70�(coupon payment 3)
(1) -$70�(coupon payment 2)
(1) -$70�(coupon payment 1)
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Putting everything together …
JOURNAL ENTRIES FOR BONDS
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $935.20
Year 0 (Bond Issuance)
Dr Bond Discount 64.80
Dr Cash 935.20
Cr Bonds Payable 1000
Year 1 (First Coupon Payment)
Dr Interest Expense (Annual Yield * Carrying Value) 84.17
Cr Cash (Coupon Payment) 70
Cr Bond Discount (Interest Expense – Cash) 14.17
Interest Expense = Annual Yield * “Carrying Value of Bond”
= 0.09 * (Face Value – Bond Discount)
= 0.09 * (1000 – 64.80)
= 0.09 * (935.20)
= $84.17
Conceptual point: why are bonds issued at a discount? Because the coupon payment (i.e., the interest payments) the company decided to pay at 7% is less than the market interest rate of 9%. So they can’t sell it at $1,000 because otherwise the bondholder would rather invest their money in the market and earn a higher interest rate.
JOURNAL ENTRIES FOR BONDS
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $935.20
Year 2 (Second Coupon Payment)
Dr Interest Expense (Annual Yield * Carrying Value) 85.44
Cr Cash (Coupon Payment) 70
Cr Bond Discount (Interest Expense – Cash) 15.44
Interest Expense = Annual Yield * “Carrying Value of Bond”
= 0.09 * (Face Value – Bond Discount)� = 0.09 * (1000 – (64.80 - 14.17))
= 0.09 * (1000 – 50.63)
= 0.09 * (949.37)
= $85.44
Year 3 (Third Coupon Payment)
Dr Interest Expense (Annual Yield * Carrying Value) 86.83
Cr Cash (Coupon Payment) 70
Cr Bond Discount (Interest Expense – Cash) 16.83
Interest Expense = Annual Yield * “Carrying Value of Bond”
= 0.09 * (Face Value – Bond Discount)� = 0.09 * (1000 – (64.80 - 14.17 - 15.44))
= 0.09 * (1000 – 35.19)
= 0.09 * (964.81)
= $86.83
JOURNAL ENTRIES FOR BONDS
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $935.20
Year 4 (Fourth and Last Coupon Payment)
Dr Interest Expense (Annual Yield * Carrying Value) 88.36
Cr Cash (Coupon Payment) 70
Cr Bond Discount (Interest Expense – Cash) 18.36
Interest Expense = Annual Yield * “Carrying Value of Bond”
= 0.09 * (Face Value – Bond Discount)� = 0.09 * (1000 – (64.80 - 14.17 - 15.44 - 16.83))
= 0.09 * (1000 – 18.36)
= 0.09 * (981.64)
= $88.36
Year 4 (Bond Retirement/Bond Maturity)
Dr Bonds Payable 1000
Cr Cash 1000
BOND ACCOUNTS OVER THE YEARS
Year 0
Year 1
Year 2
Year 3
Year 4
End (Total)
Cash Bonds Payable Bond Discount (Contra Liability) Retained Earnings (Interest Expense)
+935.20
Assets Liabilities Equity
+1000
-64.80
-70
+14.17
-84.17
+15.44
+16.83
+18.36
-85.44
-86.83
-88.63
$0
-70
-70
-1070
-1000
$0
-344.8
-344.8
PROBLEM SET 8 QUESTION 1
BOND TERMS
Term to Maturity (total): 4 Years
Coupon Rate: 6%
Face Value: $1000
On January 2, 2019, the Tenenhouse Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2021, the Tenenhouse bonds were trading at a price that provided an annual yield of 10%. Tenenhouse’s management was considering purchasing the Series A bonds in the open market and retiring them. Record the purchase and retirement of one Series A bond on January 2, 2021.
Year 0
Year 1
Year 2
Year 3
Year 4
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.06 * 1000 = $60
(2) -$1,000
(repayment of the “face value”)
(1) -$60�(coupon payment 4)
(1) -$60�(coupon payment 3)
(1) -$60�(coupon payment 2)
(1) -$60�(coupon payment 1)
January 2, 2019
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
PROBLEM SET 8 QUESTION 1
BOND TERMS
Term to Maturity (total): 4 Years
Coupon Rate: 6%
Face Value: $1000
Annual Yield (on Jan 2, 2021): 10%
Price of the Bond: $?
On January 2, 2019, the Tenenhouse Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2021, the Tenenhouse bonds were trading at a price that provided an annual yield of 10%. Tenenhouse’s management was considering purchasing the Series A bonds in the open market and retiring them. Record the purchase and retirement of one Series A bond on January 2, 2021.
Year 0
Year 1
Year 2
Year 3
Year 4
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.06 * 1000 = $60
(2) -$1,000
(repayment of the “face value”)
(1) -$60�(coupon payment 4)
(1) -$60�(coupon payment 3)
(1) -$60�(coupon payment 2)
(1) -$60�(coupon payment 1)
January 2, 2019
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
Where (in time) “Tenenhouse Financial Corporation” is standing when they repurchase the bond (right after the second coupon payment)
To calculate the price of the bond: we will have to think about how much remaining cash flows (i.e., coupon payments 3 and 4 and repayment of face value) is worth
PROBLEM SET 8 QUESTION 1
BOND TERMS
Term to Maturity (total): 4 Years
Coupon Rate: 6%
Face Value: $1000
Annual Yield (on Jan 2, 2021): 10%
Price of the Bond: $?
On January 2, 2019, the Tenenhouse Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2021, the Tenenhouse bonds were trading at a price that provided an annual yield of 10%. Tenenhouse’s management was considering purchasing the Series A bonds in the open market and retiring them. Record the purchase and retirement of one Series A bond on January 2, 2021.
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.06 * 1000 = $60
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$60�(coupon payment 4)
(1) -$60�(coupon payment 3)
(1) -$60�(coupon payment 2)
(1) -$60�(coupon payment 1)
January 2, 2019
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
1 Year
2 Years
PROBLEM SET 8 QUESTION 1
BOND TERMS
Term to Maturity (total): 4 Years
Coupon Rate: 6%
Face Value: $1000
Annual Yield (on Jan 2, 2021): 10%
Price of the Bond: $?
On January 2, 2019, the Tenenhouse Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2021, the Tenenhouse bonds were trading at a price that provided an annual yield of 10%. Tenenhouse’s management was considering purchasing the Series A bonds in the open market and retiring them. Record the purchase and retirement of one Series A bond on January 2, 2021.
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.06 * 1000 = $60
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$60�(coupon payment 4)
(1) -$60�(coupon payment 3)
(1) -$60�(coupon payment 2)
(1) -$60�(coupon payment 1)
January 2, 2019
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
1 Year
PROBLEM SET 8 QUESTION 1
BOND TERMS
Term to Maturity (total): 4 Years
Coupon Rate: 6%
Face Value: $1000
Annual Yield (on Jan 2, 2021): 10%
Price of the Bond: $?
On January 2, 2019, the Tenenhouse Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2021, the Tenenhouse bonds were trading at a price that provided an annual yield of 10%. Tenenhouse’s management was considering purchasing the Series A bonds in the open market and retiring them. Record the purchase and retirement of one Series A bond on January 2, 2021.
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.06 * 1000 = $60
Year 0
Year 1
Year 2
Year 3
Year 4
(2) -$1,000
(repayment of the “face value”)
(1) -$60�(coupon payment 4)
(1) -$60�(coupon payment 3)
(1) -$60�(coupon payment 2)
(1) -$60�(coupon payment 1)
January 2, 2019
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
2 Years
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Putting everything together …
Journal Entry (Bond Repurchase and Retirement on January 2, 2021 – Part A of Problem Set 8 Question 1):�
Dr Bonds Payable 1000
Cr Cash 930.58
Cr Gain on Bond Retirement 69.42
Journal Entry (initial one in January 2, 2019 – not asked in Q1 of Problem Set 8):�
Dr Cash 1000
Cr Bonds Payable 1000
CALCULATING THE “PRICE OF A BOND”
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
Putting everything together …
Accounting Equation
Bonds Payable (Liability) - 1000
Cash (Asset) - 930.58
Retained Earnings (Gain on Bond Retirement) (Equity) +69.42
PROBLEM SET 8 QUESTION 1
BOND TERMS
Term to Maturity: 4 Years
Coupon Rate: 7%
Face Value: $1000
Annual Yield: 9%
Price of the Bond: $?
On January 2, 2019, the Tenenhouse Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2021, the Tenenhouse bonds were trading at a price that provided an annual yield of 10%. Tenenhouse’s management was considering purchasing the Series A bonds in the open market and retiring them. Record the purchase and retirement of one Series A bond on January 2, 2021.
Coupon Payment = Coupon Rate * Face Value
Coupon Payment = 0.06 * 1000 = $60
Excel Formula:
PV function on Excel
Rate = market interest rate/annual yield (10%)
Nper = number of periods (2 years)
Pmt = annual (coupon) payment (0.06*1000 = 60)
Fv = face value ($1000)
APPENDIX: DEFINITIONS