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what causes the bond liability for a bond issued at a premium to decrease each interest payment period?

what causes the bond liability for a bond issued at a premium to decrease each interest payment period?

FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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From page 9-4 of the VLN, what causes the bond liability for a bond issued at a premium to decrease each interest payment period? Group of answer choices A. Paying the interest. B. The amortization of the premium. C. Paying the principal. D. The bond liability does not decrease when a bond is issued at a premium.
Bonds can be issued (sold) for more or less than their face value. Sells at Face Amount (100%): Bond Premium (>100%): Bond Discount (<100%): Determining the Issue Price of a Bond 1. Identify the two cash flows provided by the bond (Face value-a single sum AND Interest payments [face x stated rate or if semiannual then face x % stated rate]-an annuity). 2. Compare the market rate with the stated rate to determine if bond will sell at face, premium or discount. If at face then no more calculations are needed. 3. Eliminate the stated rate, you don't need it anymore as you already know the cash flows from the bond. 4. Use the market rate and compounding periods to determine the correct factor to present value the cash flows. Practice ABC Corporation wants to issue five-year $1,000 bonds 10% stated rate paying semi-annual interest. Market rate of interest is 8%; (therefore, semiannual would be 5% stated rate and 4% market rate respectively). What is the bond issue price on January 1, 20XA? Calculate the issue price of the bond: CASH FLOW X PV FACTOR (use market rate) = Present Value Present Value of Principal (Face) Present Value of Interest Payment (Face x stated) Issue price (sales price) OR with the TI BAII Plus Calculator PMT СРТ PV IY FV The issue price: Calculate the difference: Bond issue price Bond face amount Difference Record the bond issuance on January 1, 20XA
Transcribed Image Text:Bonds can be issued (sold) for more or less than their face value. Sells at Face Amount (100%): Bond Premium (>100%): Bond Discount (<100%): Determining the Issue Price of a Bond 1. Identify the two cash flows provided by the bond (Face value-a single sum AND Interest payments [face x stated rate or if semiannual then face x % stated rate]-an annuity). 2. Compare the market rate with the stated rate to determine if bond will sell at face, premium or discount. If at face then no more calculations are needed. 3. Eliminate the stated rate, you don't need it anymore as you already know the cash flows from the bond. 4. Use the market rate and compounding periods to determine the correct factor to present value the cash flows. Practice ABC Corporation wants to issue five-year $1,000 bonds 10% stated rate paying semi-annual interest. Market rate of interest is 8%; (therefore, semiannual would be 5% stated rate and 4% market rate respectively). What is the bond issue price on January 1, 20XA? Calculate the issue price of the bond: CASH FLOW X PV FACTOR (use market rate) = Present Value Present Value of Principal (Face) Present Value of Interest Payment (Face x stated) Issue price (sales price) OR with the TI BAII Plus Calculator PMT СРТ PV IY FV The issue price: Calculate the difference: Bond issue price Bond face amount Difference Record the bond issuance on January 1, 20XA
Effective Interest Amortization (Note: this differs from the book) The purpose of the effective iInterest amortization is to get rid of the difference between the bond payable and the bond liability. Affects Income statement Affects Cash Flow Affects Liabilities on BS Bond Interest Expense Bond Interest Paid Amortization Amount Carrying value at Beginning of Period Market rate Face value Stated x at issuance (Effective Interest Rate) of bond Interest Amortization Amount %3D Use the amortization schedule below to record the first interest payment on June 30, 20XA Note: this differs from the book Determining the bond carrying value at the end of the period: Interest expense - interest payment = amount amortized + Bond carrying value at the beginning of the period Bond carrying value at the end of the interest payment period. Date İnterest expense @ .04 (1/2 market) Interest payment @ 05 (1/2 stated) Amortization Carrying Value at end 1/1/XA 6/30/XA $1,081.11 12/31/XA 6/30/XB Bond Liability (Carrying Value) Premium $1,081 (8%) XXX XXX BL XXX XXX NA XXX D B XXX XXx XXX XXX XXX $1,000 1 10 @Maturity Interest payment periods, every 6 months
Transcribed Image Text:Effective Interest Amortization (Note: this differs from the book) The purpose of the effective iInterest amortization is to get rid of the difference between the bond payable and the bond liability. Affects Income statement Affects Cash Flow Affects Liabilities on BS Bond Interest Expense Bond Interest Paid Amortization Amount Carrying value at Beginning of Period Market rate Face value Stated x at issuance (Effective Interest Rate) of bond Interest Amortization Amount %3D Use the amortization schedule below to record the first interest payment on June 30, 20XA Note: this differs from the book Determining the bond carrying value at the end of the period: Interest expense - interest payment = amount amortized + Bond carrying value at the beginning of the period Bond carrying value at the end of the interest payment period. Date İnterest expense @ .04 (1/2 market) Interest payment @ 05 (1/2 stated) Amortization Carrying Value at end 1/1/XA 6/30/XA $1,081.11 12/31/XA 6/30/XB Bond Liability (Carrying Value) Premium $1,081 (8%) XXX XXX BL XXX XXX NA XXX D B XXX XXx XXX XXX XXX $1,000 1 10 @Maturity Interest payment periods, every 6 months
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