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INTERMEDIATE FINANCIAL ACCOUNTING II

INTERMEDIATE FINANCIAL ACCOUNTING II. Welcome to ACCT 352!. PART I: OVERVIEW. FINANCING. EQUITY (CHAPTER 18). DEBT (Chapter 14). Recording/ Retirement Conversion Warrants Reporting/Fair Value. REPORTING BASIC/DILUTIVE EARNINGS PER SHARES

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INTERMEDIATE FINANCIAL ACCOUNTING II

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  1. INTERMEDIATE FINANCIAL ACCOUNTING II Welcome to ACCT 352!

  2. PART I: OVERVIEW FINANCING EQUITY (CHAPTER 18) DEBT (Chapter 14) Recording/ Retirement Conversion Warrants Reporting/Fair Value REPORTING BASIC/DILUTIVE EARNINGS PER SHARES (CHAPTER 19)

  3. KNOWLEDGE KEY POINTS: FINANCIAL REPORTING Bigger picture Outside the box External impact Global impact Expand your knowledge: Read/listen/watch News

  4. CURRENT US MARKET CURRENT ECONOMIC CONDITIONS DISCUSSION: Current US economic conditions? Is US the most important economy in the world? E.g. crisis? Why is it important? Impact on Corporations Globally

  5. FINANCIAL REPORTING & ECONOMICS What is :CAPITAL MARKET? ‘Who are the key players? ‘ ‘ Which market is bigger?

  6. BOND MARKET! • New York Stock Exchange (NYSE) is the largest centralized bond market, representing mostly corporate bonds. • Why is it important for us to know the US/Global perspective of BOND/STOCK MARKET? Source: Securities Industry & Financial Markets Association (SIFMA)

  7. LONG TERM FINANCINGCORPORATION’S PERSPECTIVE OPTIONS:ISSUE: PRO/CON BOND MARKET STOCK MARKET

  8. MAJOR DIFFERENCES:Debt Financing & Equity Financing

  9. Professor Vedd NATURE OF BONDS • Bond Certificates- • Bond borrowing agreement: • Indenture or covenants

  10. Bond Selling Price Bond Certificate Subsequent Periods Interest Payments Company Issuing Bonds Investor Buying Bonds Face Value Payment at End of Bond Term Bonds At Bond Issuance Date Company Issuing Bonds Investor Buying Bonds

  11. The Bond Indenture Debenture Bondsecured by the “full faith and credit” of company.unsecured Mortgage Bond secured by lien on specific real estate owned by the issuer. The specific promises made to bondholders are described in a document called a bond indenture. Coupon Bond pays interest when investor submits attached coupon. Callable Bond allows company to buy back outstanding bonds prior to maturity.

  12. Professor Vedd PROVISIONS: BONDS • Callable/Redeemable bonds: • Convertible bonds:

  13. ACCOUNTING FOR BONDS BONDS: • Recording/Reporting/Issue of bonds • Interest payment/accruals (during the term • Presentation/disclosures • Reporting Changes in Fair Value RETIREMENT: • Prior to Maturity CONVERSION: • Convert Bonds to Stock • STOCK WARRANTS

  14. US GAAP & IFRS LONG TERM DEBT • US GAAP: • APB Opinion 21 (Issue costs) & • APB Opinion 14 (convertible debt) • SFAS No 159/157: The Fair Value Option • FASB ASC Topic 470 / IAS 1 • IFRS: IAS 32 & 39

  15. FEATURES OF BONDS • FACE VALUE: • Nominal/principal • Par value or maturity value. • MATURITY DATE • INTEREST RATE: • Rate Printed on Bond: Stated/face/coupon/nominal rate • Determines cash interest payments • Market Interest Rate (effective rate) (Yield) • Rate in effect when bonds are issued

  16. DETERMINE PRICE OF BONDS TWO WAYS: 1. NYSE/WSJ etc • Quoted: percentage of face amount • Bonds are quoted as a % of face value e.g. 98

  17. DETERMINE PRICE OF BONDS TWO WAYS: 2. PRESENT VALUE(PV) • PV of the future cash flows:= A. PV: interest: annuity PAYMENT (Stated Interest Rate) plus B. PV of the Face/Par Value • Discounted at the market (yield) rate of interest in effect at issue date.

  18. Bond Interest Rates Bond Stated Rate = 9% Market Rate = 8% Market Rate = 9% Market Rate = 10% Bonds Sell ata Premium Bonds Sell At Par (Face) Bonds Sell at a Discount

  19. Year 1 Year 2 Year 3 Year 4 Year 5 $9,000 $9,000 $9,000 $9,000 $9,000 Discount at market rate, 11% $9,000 * 3.69590 $ 33,263 Discount at market rate, 11% $100,000 * 0.59345 $100,000 $ 59,345 Bond Valuation ILLUSTRATION plus =$92,608 is the issue price

  20. In Class Illustration: Example A On January 1, 2012, JJ Corporation issues $500,000 long-terms bonds with stated interest rate of 10%, due on January 1, 2017.  Interest is paid semiannually on January 1 and July 1 each year.  At the time of issuance, market interest rate is 12%.  December 31 year-end Step 1: Calculate the price of the bond Step 2: Record the issue of bonds Jan 1, 2012 Step 3: Prepare schedule of interest expense Step 4: Record entries for interest expense/payments for 2012 Step 5: Presentation: statement December 31, 2012

  21. Cont. Example A: Calculating the Price of the Bond PV of interest payments PV: ordinary annuity (6%, 10 periods)    = ($500,000 x 5%) x 7.3601 $184,002 Present Value (PV of principal)    = $500,000 (6%, 10 periods)    = $500,000 x 0.5584 $279,200    BOND PRICE = $463,202

  22. Record the issue of bonds Face Value: $500,000 Sold: $463,202 Issued $36,798 discount. Date: January 1, 2012 Dr. Cash 463,202 Dr. Discount on Bonds Payable 36,798 Cr. Bonds payable 500,000

  23. Effective interest methodAmortize premium/discount

  24. Reporting: Statement Presentation JJ Corporation Partial Balance Sheet December 31, 2012 Current Liabilities: Interest Payable $25,000 LT Liabilities Bonds Payable $500,000 Less: Discount on Bonds Payable (31,046) $468,954  Discount on bonds Payable 36,798 – (2,792+2,960) = 31,046

  25. Determining the 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 threeyears. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup.

  26. Determining the 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 threeyears. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup. Present value of an ordinary annuity of $1: n=6, i=7% present value of $1: n=6, i=7% 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.

  27. 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

  28. LESSON 1: CHAPTER 14 PART II • BONDS ISSUE COST • BONDS ISSUED INBETWEEN DATES • RETIREMENT OF BONDS • CONVERSION OF BONDS

  29. Bond Issue Costs What is Bond issue Costs? • According to FASB: (APB21) • Debt issue costs are recorded separately as an asset. • Amortized over the term to maturity using straight line method.

  30. U. S. GAAP vs. IFRS Debt issue costs (called transaction costs under IFRS) are accounted for differently by U.S. GAAP and IFRS. • Debt issue costs are recorded separately as an asset. • Amortized over the term to maturity. • “Transaction costs” reduce the recorded amount of the debt. • The cost of these services reduces the net cash the issuing company receives and the amount recorded for the debt.

  31. BONDS ISSUEDBETWEEN INTEREST DATES • Bonds issued between interest days • Interest accrues from the date of the bonds • Buyer is required to pay accrued interest • Accrued interest is reported as interest payable (current liability) • Year-end Between interest dates

  32. Corp. pays full 6 months’ of interest of $3,000 Investor pays face value + Accrued interest $100,000 + $500 ($100,000 x 6% x 1/12) Issued between interest date:April 30th issued $100,000 6% bonds on May 31 April 30 Bond Date May 31 Issue Date Oct 31 Interest Payment Date

  33. Retirement of Bonds: Extinguishment of Debt(Bonds Refinancing)* • Bonds retired at Maturity or Early • Bonds may be “Called” (Reacquisition) • or “Redeemed” retired prior to maturity • May be for all outstanding bonds, or a portion *Refinancing or refunding: issuing new bonds and applying the proceeds to the retirement of outstanding bonds/debts before maturity

  34. Early Extinguishment of Debt(FASB 145)- Update the relevant accounts: (premium/discount and any issue costs)- Carrying Value (book value) Debt retired before maturity may result in an gain or loss on extinguishment. Cash Proceeds – Book Value = Gain or Loss The FASB requires that the gain or loss be classified in the Income Statement as(OTHER gains/losses) unusual/infrequent Debt retired at maturity results in NO gain/losses

  35. Convertible Bonds • Sell the bonds at higher price (lower interest rate) • In-Direct way of selling stock • Medium of exchange in business combination • ….

  36. Convertible Bonds • exchanging bond -> common stock updates interest expense and amortization of discount or premium to the date of conversion. The bonds are reduced and shares of common stock are increased.

  37. Professor Vedd Convertible bonds: Option of converting the bonds into common stock. The conversion may be recorded under either Book value method (more common) or Market value method

  38. CONVERSION OF BONDS:BOOK VALUE METHOD • NO gain or loss is recognized STEPS: 1. Update the accrued interest up to the conversion date, 2. Amortize the bond discount or premium up to the conversion date, 3. Amortize the bond issue costs up to the conversion date, and 4. Record any difference as additional paid-in capital. (stocks are with par value)

  39. CONVERSION OF BONDSMARKET VALUE METHOD • recognized gain or loss.: using Market Value Method • At conversion: • The difference between the market value of the stock • &the book value of the bonds =gain or loss on CONVERSION.

  40. Bonds with Detachable Warrants • Attraction for Investor • Bonds are issued with an instrument -added value i.e. warrant • Stock warrants: • option to purchase: • a specified number of COMMON shares • specified option price per share • within a stated period.

  41. STOCK WARRANTS • Bonds issued in conjunction with stock warrants. • Bonds/warrants issued as elements of a single security • Investors can trade the stock warrants separately • Issuer is required to allocate the joint issuance price between the two instruments

  42. Reporting Debt at Fair ValueSFAS No 159 • Not Required: but option to value (some or all) liabilities at Fair Value • If option is elected: • Increase/decrease in fair value is reported as a unrealized loss/gain in the income statement

  43. Professor Vedd FAIR VALUE REPORTING(SFAS No 157) To determine FV : present value of the remaining cash flows discounted at the current interest rate. At December 31, 18 of the original 20 payments remain.

  44. Calculating FV To determine FV : present value of the remaining cash flows discounted at the current interest rate. REMAINING 18 PERIODS If the current interest rate is 9% (4.5% semi-annually), Present Values Interest $ 32,000¥ x 12.15999*=$389,120Principal $800,000 x 0.45280† = 362,240 Present value of the bonds $751,360 ¥ (8% / 2) x $800,000 * Present value of an ordinary annuity of $1: n = 18, i = 4.5%. (Table 4) † Present value of $1: n = 18, i = 4.5%.

  45. Reporting FV To increase the book value of $706,483 to Fair Value $751,360 entry: Unrealized holding loss 44,877 Fair value adjustment ($751,360 – $706,483) 44,877

  46. BALANCE SHEET PRESENTATION DECEMBER 31 LONG TERM LIABILITIES: BONDS PAYABLE $800,000 LESS DISCOUNTS ON BONDS (93,517) CARRYING VALUE AT DEC. $706,483 Fair value adjustment ($751,360 – $706,483) 44,877 ADJUSTED CARRYING VALUE AT FV $751,360

  47. Professor Vedd Debt Financing: Chapter 14:Summary • Debt financing • Introduction • Various financing • Introduction: Bonds & various types of bonds • Accounting/recording: BONDS • Bonds payable issued at discount/premium… • Bonds Issued between interest dates • Retirement/Redemption of bonds • Convertible bonds • Bonds refinancing • Stock Warrants • Fair Value Reporting

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