Bond Related Journal Entries

Season's Greetings to Dear Reader!

Continuing from my last post on "Effective Interest Method", I am going to call attention to the journal entries in the books of issuer and investor.

Note:- The issuer's books will always reflect bond premium or discount account but the investor's books illustrate the bond investment amount all inclusive (no discount or premium account).

Given below are the facts of the case for which I have charted the interest amortization table and its related journal entries. Please use the link below to view the file.

Facts of the case
On Jan 2, 2008, a $1,000 face value, 2 year bond with a 10% coupon rate of interest is issued for 104. The market rate of interest is 7.75%. Interest is payable annually.

http://www.docstoc.com/docs/21196042/Interest-Amortization

This was a simple exercise but the rules of the game remain the same even for extensive problems. The key is to remember the timing of interest payments.

I must admit you continue to be my strength and motivation and that brings out the best in me.

With Every good Wish for your Happiness this wonderful Season and coming New Year!

 
Aprajita 

Effective Interest Method

Dear Visitor

Thanks for reading my blog and being a part of it. Every encouraging word received from my readers  strengthens and motivates me to work with novel energy and commitment.

Today, I will converse on one of my favorite topics Effective Interest Method. This is a pervasive term and its application impacts recognition of Debentures, Bonds and Lease Obligations in the financial statements. I will try to keep the discussion as straightforward as I can and explain it in minimal steps.

Before jumping into the minutiae of the topic, we must give a passing glance to the following terms:

• Amortization – process of allocation of expense over the periods benefited.

• Carrying Value – Face Amount of Debt + unamortized premium or discount + unamortized issue costs.

• Cash Interest Paid –  Stated Rate of Interest * Face Value of the Instrument.

• Discount – When an instrument (for e.g. bond) is issued for less than its face value, the difference between the face value (for e.g. $ 100) and the issue price (for e.g. $ 98) is called discount ($ 2.00). This happens when the market rate of interest is more than the stated rate on the instrument.

• Effective Interest Method – Amortizing the discount or premium to interest expense so as to generate a constant rate of interest when applied to the amount of debt outstanding (Carrying Value) at the beginning of any period.

• Effective Interest Expense –  Carrying Value of the Instrument * Effective Interest Rate.

• Face Value – The stated amount or the principal due on the maturity date.

• Market rate – The current rate of interest obtainable for obligations issued under similar circumstances by an issuer of equivalent creditability. The market rate is considered as the Effective Rate.

• Premium - When an instrument (for e.g. bond) is issued for more than its face value, the difference between the face value (for e.g. $ 100) and the issue price (for e.g. $ 102) is called premium ($ 2.00). This happens when the market rate of interest is less than the stated rate on the instrument.

• Stated Rate – The interest rate written on the face of the instrument.

Note:- Premiums or discounts on instruments held as a long term obligation must be amortized from the acquisition date to its maturity date. Authoritative Pronouncement, Codification Topic 835, Interest (formerly known as APB 21) specifies the usage of Interest Method for amortization of these differences.

At first, I contemplated this topic to be very puzzling. Nonetheless, I figured out that if the steps tabled below are followed religiously, one can sail through the questions in the exam without difficulty.

 • Start with identifying the face value, issue price, issue date, maturity date, stated interest rate and the market or effective interest rate of the instrument.

• Work out the premium or discount.

• Look for the timing of interest payments, i.e., is it being paid annually or semi-annually. If it is semi-annual reduce the stated and market rate to half and double the number of interest payments.

• Compute the following and plug them in a tabular format for each period:

a. Cash interest paid = face value of the bond * stated rate of interest.

b. Interest expense = Carrying value at the beginning of the period * market rate of interest

c. Premium or discount amortized = Difference between amounts per step ‘a’ and ‘b’.

d. Unamortized Premium or discount = Total premium or discount less amount amortized in step ‘c’.

e. Carrying value = Face Value + unamortized premium or Face Value – unamortized discount.

Points to Ponder

• If the instrument is issued at a discount, cash interest paid will be less than interest expense and vice versa will hold true if the instrument is issued at a premium.

• When the bond is issued at a discount, in each period there will be an increase in interest expense and amount of discount amortized leading to an increase in carrying value of bond.

• When the bond is issued at a premium, in each period there will be a decrease in interest expense and increase in premium amortized leading to a decrease in carrying value of bond.

• Once the last interest payment period is reached, premium or discount gets completely amortized and the carrying value equals the face value of the bond as the unamortized amount is NIL.

• Unlike Straight Line method of interest amortization, under this method interest expense changes each period giving constant interest rate on the carrying value.

 I will continue with this topic in my next post and look at some of the journal entries both in the books of borrower and investor.
 
Until then good bye and take care.
 
Aprajita

Comprehensive Income

Hello Dear Reader

I hope you enjoyed my last post on Basics of Accounting. For me, self study mode has always worked. However, while preparing for the CPA exam, I realized some topics needed deeper research and time constraint was the biggest challenge. At that point in time, I wished, if there was a "ready to eat" affordable package available. My endeavor is to help other CPA candidates who are in the same boat as I was.

Today's topic of discussion is Comprehensive Income and I chose this first because it is bound to be repeated over and over and is a good idea to start with.

Authoritative Pronouncement

With the introduction of new FASB Accounting Standards Codification, it is now cited as Codification Topic 220, Comprehensive Income (formerly known as FASB Statement 130).

Note that this Codification is not applicable to Not for Profit Organizations.

Definition

Simply stated, Comprehensive Income is a summation of Net income and Other Comprehensive Income “OCI”. It is “the change in equity [net assets] of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.”

OCI includes items that must bypass the income statement because they have not been realized, and are not part of net income, yet are important enough to be included in comprehensive income, giving the user a bigger, more comprehensive picture of the organization as a whole.

Components of OCI

 Unrealized holding gains and losses on available for sale securities;

 Effective portion of gain or loss on derivative instruments (cash-flow hedge);

 Foreign currency translation adjustments; and

 Minimum pension liability adjustments.

Presentation and Disclosure

Comprehensive Income can be presented in any of the following three ways:

 Single Statement Approach, wherein items of OCI are added to Net Income and is termed as the Statement of Income and Comprehensive Income;                             

 A stand-alone Statement of Comprehensive Income describing the items in OCI; or

 In a Statement of Changes in Stock-holders equity.

Note: - The components of OCI may be shown net of tax. However, if the items are shown gross of tax, tax effects related to all components has to be reported on a single, separate line. Further, using gross approach necessitates disclosure of tax effects of each component in the Notes to Financial Statements.

Reclassification

Reclassification adjustments, usually triggered through a sale, must be kept in mind to avoid double counting - once in net income in the current year and also in OCI in the earlier period. For e.g., the sale of an available-for-sale security in the current period will prompt an adjustment for the gains/losses that were included in OCI previously.

Points to Ponder

 Understand components of OCI in more detail which I will attempt to cover subsequently.

 Remember to avoid double count. Only minimum pension liabilities will not require reclassification adjustments because they will not be reported in net income in any future period.

 The tax effects of items reported in OCI must also be included in OCI.

 Statement of changes in equity must display accumulated balance of OCI separately.

I hope you will continue to remain with me and share the little I have.

With Warm Regards

Aprajita

Basics of Accounting

Hi

This is the first time I am writing a blog. I am kind of excited and nervous. Thousands of ideas are overflowing and I need a needle to thread them all into one. I would not say that I am a master of my subject but I have a fair amount of understanding and want to share it and learn more from others.

I am going to start with Basics of Accounting and then gradually pick up Financial Accounting and Reporting "FAR" topics. I am keeping my fingers crossed hoping to expand my horizons through this medium. The idea is also to help CPA candidates with the FAR section of the exam.

We all know that Accounting is a business language which helps in creating the books of accounts (recording monetary transactions), financial statements (reporting the financial information) and analyzing that information to make sound economic decisions.

It has its own set of rules, principles and terminologies. You may use www.nysscpa.org/glossary source to refer to different accounting terminologies.

The basic accounting process starts with identifying the capital employed in the business, its business expenses, the income being generated and how the business is being or will be funded. Please refer to the source http://www.futureaccountant.com/accounting-process/ where accounting fundamentals have been beautifully explained.

However, I would still like to emphasize on the following three areas:-

1. Double Entry Accounting system,
2. Nature or type of account involved and
3. Rules of Debit and Credit.

The Double Entry Accounting system signifies that a business transaction effects any of the two elements i.e asset, liabiltity, income or expense.

The Debit/Credit rules which we must always remember:
For Real Account

a. Debit what Comes in and Credit what goes out.
For Personal Account
b. Debit the receiver and Credit the giver.
For Nominal Account
c. Debit all expenses and losses and Credit all incomes and gains.

At this point in time, I would also like to refer to some of the accounting concepts and conventions. These are referred to as Statement of Financial Accounting Concepts "SFAC". They lay down the objective and fundamentals used to develop the Generally Accepted Accounting Principles "GAAP".
Accounting Qualities is one of the most important Accounting Concept. It states that the financial information to be decision-useful has to be relevant and reliable.

The other important Accounting Concept is Recognition and Measurement in Financial Statements. A set of financial statement must comprise of :-
a.Balance Sheet showing the financial position at the end of period,
b.Income Statement depicting earnings for the period,
c.Comprehensive Income for the period,
d.Cash Flow Statement for the period and
e.Owner's equity statement showing capital transactions during the period.

By Recoginition it is meant how an element of the financial statement be presented and measured so that it is meaningful and useful for the users of the financial statement information.

There are different ways in which an element can be measured, these being, Historical Cost, Net Realizable Value, Fair Market Value, Replacement Cost or Present value of discounted future cash flows.

Also based on the rule of conservatism it is prudent to recognize all expenses and losses when benefits are consumed or an asset loses a future benefit and defer revenues and gain until they are realized or earned.

Now that I have briefly touched upon accounting basics, I would like to continue to work on various GAAP topics a little more in detail. Once again I want to reiterate the fact that this is my whole and sole attempt to put down my understanding of the topic in here. I welcome all suggestions and Comments.

Thanks for reading my blog and see you again:)

Take Care

Aprajita