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BONDS AND LONG-TERM NOTES

How to raise funds
• Its own operations

• External financing

◦ Equity funding

◦ Debt funding

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Statement of Financial position
Financial Position

Assets Liabilities

Equity

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Financial Instruments
Financial Assets Financial Liabilities

• Cash at Banks • Accounts payable
• Accounts receivable • Loans from banks
• Loans to other parties • Loans from other parties
• Investments in equity instruments • Bonds / Debentures
• Investments in debt instruments

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to deliver cash or another financial asset to another entity • A Contractual right : .to exchange financial assets of financial .to receive cash or liabilities – under conditions that are . Definition of Financial Assets / Financial Liabilities Financial Assets Financial Liabilities • Cash • A contractual obligation • An equity instrument of another entity .to exchange financial assets or potentially unfavorable to the entity financial liabilities – under conditions that are potentially favorable to the entity PAGE 4 .

Bond Holders Bond Issuers Trustee Bond Indenture PAGE 5 .

Nominal value. Nominal rate PAGE 6 .so called Coupon rate.so called Principal.Key Conditions • Maturity value . Face amount • Maturity date • Interest rate .

PAGE 7 . Mortgage or secured bonds → Secured or backed by Assets. Callable (or redeemable) → Allow the issuers to buy back or call the bonds before maturity date. Subordinated debenture → The holders are not entitled to receive liquidation payment until the claims of other creditors are satisfied. The holders have same standing as other creditors.Other Conditions Debenture bond → No specific assets are pledge as security.

000 Interest 12% Interest 42.Initial recognition Company A issued bond 700.000 payable semi-annually Issuance date 1 January 2012 Maturity date 3 year 31 December 2014 PAGE 8 .

Selling Price MARKET INTEREST RATE COUPON RATE 12 % 12% Sold at Par 14% 12% Sold at Discount 10% 12% Sold at Premium PAGE 9 .

000 Dr Investment in bond 700.000 Cr Bonds 700.000 payable PAGE 10 . Sold at Par ISSUER INVESTOR Dr Cash 700.000 Cr Cash 700.

000 $42.000 Present value Principal $200.195 + 466.76654*Ɨ = $200.000 $42.195 Present value $466.000 x 4.000 $42.000 $700.000 $42.438 Present vales (price) of the bonds = $666.66634 = 466.438 Total $200.633 Jan. 31 2012 2012 2012 2013 2013 2014 2014 Interest $42.633 Present value of cash flows PAGE 11 .000 $42.31 June 30 Dec.438 = $666.195 Principal $700.Sold at Discount Calculation of the Price of the Bonds Present Values Interest $ 42.1 June 30 Dec. 31 June 30 Dec.000 x 0.

000 Dr Discount 33.633 Dr Investment in 700.000 On bonds payable Cr Cash 666. Sold of Discount (cont.637 Cr Bonds payable 700.367 bond On bonds payable Cr Discount 33.633 PAGE 12 .) ISSUER INVESTOR Dr Cash 666.

000 x 0.74622 = 522.000 Cr Bonds payable 700.533 ISSUER INVESTOR DR Cash 735.533 Cr Cash 735.000 x 5.533 Dr Investment in bonds 700.354 Present vales (price) of the bond = $735. Sold at Premium Calculation of the Price of the Bonds Present Values Interest $ 42.533 PAGE 13 .533 Cr Premium on bonds payable 35.000 Dr Premium on bond investment 35.179 Ɨ Principal $700.07569* = $213.

342) = 48..633 6/30/12 42.000 .. Effective Interest rate method Date Cash Interest Effective Interest Increase in Balance Outstanding Balance Amortisation ..000 285.288 6/30/13 42.07 (671.628 12/31/13 42.342 6/30/14 42.. 42.367 33...07 (681..340 5.07 (666..664 Cr Cash (stated rate X principal amount) ………………..991 676.000 . 42. (6% X Principal amount) (7% X Outstanding balance) (Discount reduction) Discount 1/1/12 666.714 687.. 46.544 700..114 693..664 4.07 (693.991 4.07 (687.340 681. 4..664 Dr Discount on bond investment (difference) ……………………..000 ..456 12/31/14 42..367 ISSUER INVESTOR Dr Interest expense (market rate X outstanding balance) ……..628) = 47.664 Dr Cash (states rate X principal amount) …………………….07 (676..456) = 48..544* 6.664 671.633) = 46.000 ...000 ..297) = 46.714 5.664 PAGE 14 .114 6.000 252.288) = 47.000 Cr Interest revenue (market rate X outstanding balance) …… 46.297 12/31/12 42.000 Cr Discount on bonds payable (difference) ………………………… 4.000 ...

020 6/30/14 42.241 5.000 216.223 Cr Premium on bond payable 5.067) = 35.777 5.826) = 36.310 12/31/12 42.651 6.000 .05 (706.000 252.516 5.671 700.223 Cr Cash 42.05 (730.000 Dr Premium on bond payable 5.777 Dr Cash 42.067 12/31/13 42.) Date Cash Interest Effective Interest Increase in Balance Outstanding Balance Amortisation .533 ISSUER INVESTOR Dr Interest expense 36.000 .484 724.05 (713.05 (724.329* 6.671) = 35.000 .05 (735.223 730.467 35.000 .047 713.310) = 36.759 719.671 12/31/14 42.777 PAGE 15 .000 Cr Interest Income 36.826 6/30/13 42.349 706.533) = 36.000 .533 6/30/12 42.05 (719. Effective Interest rate method (cont.020) = 35.953 6. (6% X Principal amount) (5% X Outstanding balance) (Premium reduction) Premium 1/1/12 735.000 .

991) 3.991) 31.327 Interest payable (4/6 x 42.When Financial Statements are prepared between interest dates At October 31 (Issuer) Interest expense (4/6 x 46.327 Interest revenue (4/6 x 46.000 Discount on bond investment (4/6 x 4.327 PAGE 16 .000) 28.000 (Investor) Interest receivable (4/6 x 42.991) 31.000) 28.327 Discount on bonds payable (4/6 x 4.991) 3.

When Financial Statements are prepared between interest dates (cont.991) 1.) At the December 31 Interest Date (Issuer) Interest expense (2/6 x 46.991) 15.000 Discount on bond investment (2/6 x 4.991) 1.000 Interest revenue (2/6 x 46.664 Interest payable (from adjusting entry) 28.664 Interest receivable (from adjusting entry) 28.664 PAGE 17 .000 Discount on bonds payable (2/6 x 4.000 (Investor) Cash (stated rate x principal amount) 42.664 Cash (stated rate x principal amount) 42.991) 15.

92 137.08 36.23 2037 0 8.67 2013 0 1.57 2040 0 9.74 30.65 2039 0 8.43 167.82 2012 0 1.08 2.92 *Also the internal rate of return PAGE 18 .71             2037 0 7.94 7.85 32.41 148.92 157.74 1.41 8.85 1.63 2014 0 2.08 2011 0 1.96 34.00 137. Zero – Coupon bonds Year Cash Interest Effective Interest* Increase in Balance Outstanding Balance (0% X Principal amount) (6% X Outstanding balance) (Discount reduction) Issue Date 29.43 9.94 140.96 1.92 8.

92 Cr Discount on bonds 1.74 Cr Zero-coupon bonds 167 PAGE 19 .08 Dr Interest expense 1.Zero – Coupon bonds (Cont.74 Dr Discount on bonds 137.) Issue date Year-ended date Dr Cash 29.

08  Liabilities Zero – coupon bonds 29.08  Notes to financial statement Details of zero-coupon bonds are Principal 167.Financial Statement presentation and disclosure  ISSUER .08 PAGE 20 .00 Less Discount on bonds (137.92) 29.Statement of financial position Issue date  Asset Cash 29.

92 Less Discount (136.74) 136.18 on bonds 30.18) Reduction (1.82 PAGE 21 .00 Issue date 137.) Year 2011  Liabilities Zero-coupon bonds 30.Financial Statement presentation and disclosure (cont.82  Notes to financial statement Details of zero – coupon bonds are Discount on bonds Principal 167.

Long-term notes The Company can purchase Assets on credit • Company A purchase machinery • issuing 12%. 700.000. three-year notes • Cash price of this machinery 666.633 • implies that market rate is 14% PAGE 22 .

) Present Values Interest $42.Long-term notes (cont.000 PAGE 23 .195 Principal $700.00 X 0.66634 = 466.000 X 4.367 Notes payable 700.633 Purchase date Dr Machinery 666.633 Dr Discount on note payable 33.76654 = $200.438 Present value of the note $666.

07 (671.297 12/31/12 42.288) = 47.991 4.114 393.07 (687.000 285.000 .297) = 46.07 (693.000 252.342) = 48.07 (666.664 671.) Date Cash Interest Effective Interest Increase in Balance Outstanding Balance (6% X Principal amount) (7% X Outstanding balance) (Discount reduction) 1/1/12 666. Long-term Notes (cont.000 .288 6/30/13 42.000 .714 5.633) = 46.07 (676.544* 6.342 6/30/14 42.000 .000 .714 687.456 12/31/14 42.628 12/31/13 42.367 33.340 681.664 4.544 700.633 6/30/12 42.991 676.000 .07 (681.367 PAGE 24 .456) = 48.340 5.114 6.628) = 47.

000 PAGE 25 .) Interest paid date Dr Interest expense 46.644 Cr Discount note payable 4.Long-term notes (cont.664 Cr cash 42.

724 6/30/13 139.857 .863) = 17.700 122.706) = 9.857 .509 666.724) = 33.028) = 25.857 .142 172.716 473.161 106.07 (252.07 (666.028 12/31/13 139. Installment Notes Date Cash Payment Effective Interest Decrease In Debt Outstanding Balance (7% X Outstanding balance) 1/1/12 666.440) = 40.952 114.863 6/30/14 139.165 252.151* 130.664 93.07 (367.857 .07 (473.07 (130.857 .706 0 839.969 367.633 PAGE 26 .633) = 46.157 130.857 .07 (573.440 12/31/12 139.141 99.706 12/31/14 139.633 6/30/12 139.193 573.

Installment Notes (cont.664 Dr Notes payable 93.857 PAGE 27 . Interest expense 46.) Company A – Buyer Purchase Date Dr Machinery 666.193 Cr Cash 139.633 Cr Notes payable 666.633 Interest paid date Dr.

Early Extinguishment of debt  Debt paid in installments is systematically retired over the term of maturity  Any discount or premium is systematically reduced to zero as of maturity date  Gain / loss may result when debt is repaid before its scheduled maturity PAGE 28 .

Early Extinguishment of debt (cont.) Consideration paid for debt Carrying amount settlement of Debts before maturity date Difference is recognized in profit or loss PAGE 29 .

114 6.991) ◦ Cr Cash 685.07 (666.07 (671.000 ◦ Dr Loss on early extinguishment 8.712 33.000 .) Date Cash Interest Effective Interest Increase in Balance Outstanding Balance (6% X Principal amount) (7% X Outstanding balance) (Discount reduction) 1/1/12 666.340 681.000 .456 12/31/14 42.340 5.544* 6.000 285.991 4.07 (676.342 6/30/14 42.664 671.000 ◦ Dr Notes payable 700.342) = 48.07 (693.664) ◦ Cr Discount on notes payable 23.367 (4.288) = 47.544 700.633) = 46.714 687.000 PAGE 30 .000 . Call price is 685.000 252.456) = 48.628 12/31/13 42.288 6/30/13 42.714 5.297) = 46.991 676.000 .664 4. Early Extinguishment of debt (cont.000 .000 .367 On 1 Jan 2013 The Company early repaid notes payable.07 (687.297 12/31/12 42.628) = 47.712 (4.367 33.07 (681.114 393.633 6/30/12 42.

Convertible Bonds • Convertible bonds can be converted into shares of stock at the option of holder • The conversion feature is attractive to investors • This hybrid security has features of both debt and equity PAGE 31 .

PAGE 32 . 2012 HTL Manufactures issued $100 million of 8% convertible debentures due 2032 at 103 (103% of face value).000 bond. 20-year. The bonds are convertible at the option of the holder at a conversion ratio of 40 shares per $1. 8% debentures at 98.Convertible Bonds (cont.)  On January 1. HTL recently issued nonconvertible.

..Convertible Bonds (cont....$98 million) ………………….. 100 Equity options ($103 million ... 5 PAGE 33 ........ 2 Convertible bonds payable (principal amount) ………………………………………... 103 Discount on bonds payable ($100 million ..........) Convertible bond Pure bond Conversion option = + Fair value of type bond = Present value of future Proceeds from the cash outflows discounted convertible bond at effective interest rate minus the fair value of the pure bond ($ in millions) Cash (103% x $100 million) …………………………………………………………………………...$98 million) …………………………………..

365 46.139. Convertible bonds 100 100.170 50.000 12/31/12 8.078 12/31/14 8.042. Equity options 5 Cr.000.248 Assume that convertible bonds are converted on 31/12/2014 Dr.Convertible Bonds (cont.365 98.170 98.000.050.000 8.713 42.713 98.000.042. Discount bonds 1.000 8.046.000.14 PAGE 34 .86 Cr.089.) Date Cash Payment Effective Interest Increase in Debt Outstanding Balance 1/1/12 98.000 8.713 12/31/13 8.000 Dr.000. Share capital 103.

Debt Restructuring • When original terms of a debt agreement are changing because of financial difficulties experienced by the debtor. the new agreement is referred to as “ Troubled Debt restructuring” PAGE 35 .

Troubled Debt restructuring • The debt may be settled at the time at the restructuring • The debt may be continued. but with modified terms PAGE 36 .

20 PAGE 37 .. 3 Gain on transfer of assets ……………………………………………………… 3 Note payable (carrying amount) ………………………………………………. 30 Gain on debt restructuring ……………………………………………………. The carrying amount of the property on BLL’s book is $17 million: ($ in millions) Land ($20 million minus $17 million) …………………………………………. 10 Land (fair value) …………………………………………………………………….Debt is settled  Frist Prudent Bank agrees to settle BLL’s $30 million debt in exchange for property having a fair value of $20 million.

67% Under IAS39. the difference at least 10% would indicate “substantially different ” PAGE 38 .Debt is continued. but with modified term Original Term Revised Term Difference Principal 30 25 5 Interest rate 10% 10% Annaul Interest payment Reduce 16.

Debt is continued. 5 Effectively. but with modified term (cont. PAGE 39 . the net adjustment of $5 million to loan payable removes the original loan of $30 million and recognizes a new loan of $25 million.) ($ in millions) Loan payable …………………………………………………………………… 5 Gain on extinguishment of loan payable …………………….

Reduce the remaining two interest payments to $2 million each. Forgive the interest accrued from last year. Reduce the principal to $25 million. 3.Loans are substantially modified BLL Properties owes First Prudent Bank $30 million under a 10% note with two years remaining to maturity. 4. The implicit interest rate of the restructured loan is 8% PAGE 40 . the previous year’s interest ($3 million) was not paid. Due to financial difficulties of the developer. 2. Frist Prudent Bank agrees to: 1.

Loans are substantially modified (cont.) Carrying amount Before restructure Adj. After Restructure Loans payable 30 (5) 25 Interest payable 3 (3) - 33 (8) 25 PAGE 41 .

08) + $25 million/(1. we have ignored transaction costs and fees) PAGE 42 .08) = $25 million ($ in million) Loan payable ……………………………………………………………………….Loans are substantially modified (cont.) Analysis: Carrying amount of = 30 million + $3 million = $33 million existing loan 2 2 Fair value of new loan = $2 million/(1.08) + $2 million/(1.. 5 Interest payable …………………………………………………………………… 3 Gain on debt restructuring ……………………………………………… 8 (For simplicity.

25 PAGE 43 .Loans are substantially modified (cont. 2 Cash (revised “interest” amount) ……………………………… 2 At Maturity Loan payable ………………………………………………………………….) At Each of the Two Interest Dates ($ in Million) Interest expense ……………………………………………………………. 25 Cash (revised principal amount) ………………………………..

405 PAGE 44 . First Prudent Bank agrees to: 1.000 at that time in full settlement of the debt.Loans are not substantially modified BLL Properties owes First Prudent Bank $30 million under a 10% note with years remaining to maturity. 2.231. Analysis: Carrying amount of = $30 million + $3 million Existing loan = $33 million 2 Fair value of loan = $39 million/(1.000. the previous year’s interest ($3 million) was not paid. Due to BLL’s financial difficulties. Accept $39. Delay the due date for all cash payments until maturity.10) Under the revise terms = $32.

) BLL continues to recognize the original loan at the original interest rate of 10%. BLL recognizes a one-time gain of $768.930.Loans are not substantially modified (cont. However.301. ) PAGE 45 . ($ in million) Loan payable 0.595 from the revision to future cash flows.699 Accrued interest payable 0.0699 Gain on adjustment of carrying amount 0.277 and the revised accrued interest payable is $2.128.768 (The above entry pro-rates the gain proportionately between the principal amount of $30 m and accrued interest payable of $3 million.) The revised loan principal is now $29. the revised terms have altered the future cash flows and BLL has to determine the new fair value of the existing loan.

140 Accrued interest payable …………………………………………………………….223.128 + 3.223. 3.723 Cash (required by new agreement) …………………………………………… 39.000.128)] …………………….930.455) …… 9.140 At the end of the Second Year Interest expense [10% x ($29. 3.140 + 3.301.930.545. 3.000 PAGE 46 .545.128 + 3.455 Accrued interest payable …………………………………………………………….301.455 At Maturity (End of the Second Year) Loan payable ………………………………………………………………………………….698.277 + $2.Loans are not substantially modified (cont.301.) At the End of the First Year Interest expense [10% x ($29. 29.223.223.545.277 + $2. 3.140)] ….930.277 Accrued interest payable ($2.