Bonds and Long-Term Notes,9,Bonds,At Bond Issuance Date,Company Issuing Bonds,Investor Buying Bonds,Recording Bonds at Issuance,On January 1, 2011, Masterwear Industries issued $700,000 of 12% bonds. Interest of $42,000 is payable semiannually on June 30 and December 31. The bonds mature in three years. The entire bond issue was sold in a private placement to United Intergroup, Inc. at face amount.,At Issuance (January 1),Masterwear (Issuer) Cash 700,000 Bonds payable 700,000,United (Investor) Investment in bonds (face amount) 700,000 Cash 700,000,Determining the Selling Price,Determining the Selling Price,On January 1, 2011, Masterwear Industries issued $700,000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup.,Because interest is paid semiannually, the present value calculations use: (a) the semiannual stated rate (6%), (b) the semiannual market rate (7%), and (c) 6 (3 x 2) semi-annual periods.,Present value of an ordinary annuity of $1: n=6, i=7%,present value of $1: n=6, i=7%,Bonds Issued at a Discount,Masterwear (Issuer) Cash 666,633 Discount on bonds payable 33,367 Bonds payable 700,000,United (Investor) Investment in bonds 700,000 Discount on bond investment 33,367 Cash 666,633,Determining Interest Effective Interest Method,Interest each period is recorded as the effective market rate of interest multiplied by the outstanding balance of the debt (during the interest period).,Interest is recorded as expense to the issuer and revenue to the investor. For the first six-month interest period the amount is calculated as follows: $666,633 (14% 2) = $46,664 Outstanding Balance Effective Rate Effective Interest,Recording Interest Expense,The effective interest is calculated each period as the market rate times the amount of the debt outstanding during the interest period.,At the First Interest Date (June 30),Masterwear (Issuer) Interest expense 46,664 Discount on bonds payable 4,664 Cash 42,000,United (Investor) Cash 42,000 Discount on bond investment 4,664 Investment revenue 46,664,$700,000 (12% 2) = $42,000,$666,633 (14% 2) = $46,664,$46,664 - $42,000 = $4,664,Bond Amortization Schedule,Here is a bond amortization schedule showing the cash interest, effective interest, discount amortization, and the carrying value of the bonds.,$666,633 + $4,664 = $671,297,Bond Issued at Premium,On January 1, 2011, Masterwear Industries issued $700,000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 10%. The entire bond issue was purchased by United Intergroup.,Present value of an ordinary annuity of $1: n=6, i=6%,present value of $1: n=6, i=5%,Premium Amortization Schedule,Here is a bond amortization schedule showing the cash interest, effective interest, premium amortization, and the carrying value of the bonds.,$735,533 - $5,223 = $730,310,$735,533 5% = $36,777,Bonds Sold at a Premium,Masterwear (Issuer) Cash 735,533 Premium on bonds payable 35,533 Bonds payable 700,000,United (Investor) Investment in bonds 700,000 Premium on bond investment 35,533 Cash 735,533,Interest expense and interest revenue will be recognized in a manner consistent with bonds issued at a discount.,Premium and Discount Amortization Compared,1/1/11,12/31/13,$700,000,$735,533,$666,633,Premium Amortization,Discount Amortization,When Financial Statements Are Prepared Between Interest Dates,On Mar 1, 2011, Masterwear Industries issued $700,000 of 12% bonds. Interest is payable semiannually on Aug 31 and Feb 28. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup at a cost of $666,633.,$700,000 (12% 2) = $42,000,$666,633 (14% 2) = $46,664,Semi-annual Stated Interest,Aug 31, 2011 Effective Interest,When Financial Statements Are Prepared Between Interest Dates,before the second interest date of Feb 28, so we must accrue interest for 4 months from Aug 31 to Dec 31.,Year-end accrual of interest expense and interest income.,Masterwear (Issuer) Interest expense 31,327 Discount on bonds payable 3,327 Interest payable 28,000,United (Investor) Interest receivable 28,000 Discount on bond investment 3,327 Investment revenue 31,327,$42,000 4/6 = $28,000,$671,297 7% 4/6 = $31,327,$31,327 - $28,000 = $3,327,When Financial Statements Are Prepared Between Interest Dates,On Feb 28, the next interest payment date, the following entries would be recorded.,Masterwear (Issuer) Interest expense 23,496 Interest payable 21,000 Discount on bonds payable 2,496 Cash 42,000,United (Investor) Cash 42,000 Discount on bond investmen