The par or face value and the coupon interest rate determine the promised cash payments on a bond.

The promised cash payments on a bond and the historical market interest rate determine the book value of the bond.

The promised cash payments on a bond and the current market interest rate determine the current market value of the bond.

Question 9.11 asks students to make these distinctions.

Then illustrate the calculation of initial issue proceeds for a 12-percent, semiannual coupon bond with a par or face value of $100,000 maturing in 10 years. The issue price differs depending on the market required interest rate, or yield, at the time of issue. The issue price equals the par or face value if the market interest rate equals the coupon rate of 12 percent compounded semiannually. The issue price exceeds the par or face value if the market interest rate is less than the coupon rate. The issue price is less than the par or face value if the market interest rate exceeds the coupon rate. The entries that the accountant might logically make for these three possibilities appear below (Schedule 9.1 in this instructor's manual shows the supporting computations):

Time of Issue: Market Interest Rate at Time of Issue

12% 10% 14%

Cash....................................... 100,000 112,462 89,406

Present Value of

Coupon Payments.......................... 68,820 74,773 63,564

Present Value of

Principal Payment.......................... 31,180 37,689 25,842

Even though these entries at the time of issue capture the economics of the two promised types of future cash flows, accounting typically records both in a single credit entry to bonds payable. Some textbooks use a bond premium or bond discount account when the issue price differs from the par or face value of the bonds. We find this approach confusing to students. Showing a single amount in the bonds payable account permits the generalization that the book value of a bond always equals the present value of the bond's promised future cash flows discounted at the historical market interest rate.

We assign one or two problems that require students to compute the issue price of bonds (Exercises 9.26 and 9.27) before introducing the calculation of periodic interest expense. We find that this sequencing hammers home the concept that the initial book value is a present value calculation. We also introduce the use of bond tables at this point (Exercise 9.31).

...

Schedule 9.1

10-Year Semiannual 12% Coupon Bond

$1,000 par Value

Yield

10 Years to Go 10% 12% 14%

Principal............................. $ 1,000 X .37689 $ 1,000 X .31180 $ 1,000 X .25842

Coupons.............................. $ 60 X 12.46221 $ 60 X 11.46992 $ 60 X 10.59401

$ 376.89 $ 311.80 $ 258.42

747.73 688.20 635.64

$ 1,124.62 $ 1,000.00 $ 894.06

9.5 Years to Go

Principal............................. $ 1,000 X .39573 $ 1,000 X .33051 $ 1,000 X .27651

Coupons.............................. $ 60 X 12.08532 $ 60 X 11.15812 $ 60 X 10.33560

$ 395.73 $ 330.51 $ 276.51

725.12 669.49 620.14

$ 1,120.85 $ 1,000.00 $ 896.65

9.0 Years to Go

Principal............................. $ 1,000 X .41552 $ 1,000 X .35034 $ 1,000 X .29586

Coupons.............................. $ 60 X 11.68959 $ 60 X 10.82760 $ 60 X 10.05909

$ 415.52 $ 350.34 $ 295.86

701.38 649.66 603.55

$ 1,116.90 $ 1,000.00 $ 899.41

Schedule 9.2

12% Semiannual Coupon 10-Year Bonds

Issued to Yield 10%

10 Years to Go: Borrow $112,462.

9.5 Years to Go: Interest Expense = .05 X $112,462 = $5,623. Pay $6,000 in Cash.

Dr. Interest Expense..................................... 5,623

Cr. Cash..................................................... 6,000

Dr. Bonds Payable (Premium) 377

Borrowing is now: $ 112,462

– 377

$ 112,085

9 Years to Go: Interest Expense = .05 X $112,085 = $5,604. Pay $6,000 in Cash.

Dr. Interest Expense..................................... 5,604

Cr. Cash..................................................... 6,000

Dr. Bonds Payable (Premium)...................... 396

Borrowing is now: $ 112,085

– 396

$ 111,689

Note that 1.05 X $377 = $396.

Amount amortized grows by 5 percent per period.

Schedule 9.3

12% Semiannual Coupon 10-Year Bonds

Issued to Yield 14%

10 Years to Go: Borrow $89,406.

9.5 Years to Go: Interest = .07 X $89,406 = $6,258. Pay $6,000 in Cash.

Dr. Interest Expense..................................... 6,258

Cr. Interest Payable (or Cash)................ 6,000

Cr. Bonds Payable (Discount)................. 258

Borrowing is now: $ 89,406

+ 258

$ 89,664

9 Years to Go: Interest = .07 X $89,664 = $6,276. Pay $6,000 in Cash.

Dr. Interest Expense..................................... 6,276

Cr. Interest Payable (or Cash)................ 6,000

Cr. Bonds Payable (Discount)................. 276

Note that 1.07 X $258 = $276; amortization amount grows by 7 percent per period.

Borrowing is now: $ 89,664

+ 276

$ 89,940

See also Accountancy 3000 web site – additional material for Ch 7