Bonds: Between Interest Dates

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Accounting Analysis II: Measurement and Disclosure of Liabilities

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University of Illinois at Urbana-Champaign

Accounting Analysis II: Measurement and Disclosure of Liabilities

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Cours 3 sur 5 dans Specialization Financial Reporting

This course is the third course in the five-course Financial Reporting Specialization. This course begins with a discussion of current liabilities and contingencies and continues with long-term debt and bonds. The course next explores accounting model for leases, both lessees and lessors, and a discussion on deferred tax assets and liabilities. Participants will learn the latest accounting standards including the new accounting model for leases effective for public companies in 2019 and private companies in 2020.

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Module 2: Long-Term Debt Part 1

In this module, you will be introduced to the concept of long-term debt. You will learn about the different types of bonds and how each type results in different accounting, including bonds sold at a premium, sold at a discount, and sold with issuance costs attached. The module also describes the fair value option that is offered for accounting for a bond.

Bonds: Between Interest Dates6:46

Rencontrer les enseignants

John Hepp
Clinical Assistant Professor of Accountancy
Department of Accountancy

[MUSIC]

Welcome back, in this lesson we'll talk about what happens when you

issue a bond between interest dates.

So so far we looked at a highly simplified example that doesn't include any discount

or premium, and the bond is issued exactly at the beginning of the interest period.

We're going to add a layer of complexity and illustrate how to account for

a bond that's issued between interest dates.

This is actually a very common situation.

Why, because the issuance of bonds is a very complex process.

There's lots of accountants involved, there's lawyers involved.

There's a whole lot of things involved.

Getting things issued on a specific date is not always possible,

and frankly, people rarely even try.

What's going to happen is, when it's issued between the interest dates,

usually the investor will make an additional payment for the amount of

accrued interest, the amount of interest that's already accrued on the bonds.

And then of course they get that amount back when the first interest

payment is made.

So let's take our example.

This is the previous example that we used, again, issuing bonds of 10 million

at 6% interest payable semi-annually, June 30 and December 31.

But now we'll make one small adjustment to the problem,

and that small adjustment is that they're issued on March 1, 2017.

So what does that mean?

Well, they're two months into the first interest period.

The first interest period started January 1st,

because the first interest is going to be paid on June 30th.

So we're two months in to the first interest period.

So what that means is that of the 300,000 that would be due on June

30th, 100,000 is already quote unquote accrued or due.

So we're going to assume that the investor pays that $100,000 in.

They will get it back when the interest is paid.

So it's the same mathematics that we had on our previous example just with

the adjustment for this 100,000 payment that the investor's making

on March 1st that they'll get back on June 30th.

So let's look at it.

So once again, that interest that was already accrued,

already due on March 1st would be 6% times now 60/360.

The number of days it's already been accrued, times 10 million equals $100,000.

And we're assuming that the investor has paid the interest.

So there's a slight difference on that initial journal entry, and

here's what it looks like.

I'm receiving more cash.

I'm receiving 10,100,000 in cash up front.

My bonds payable will still be $10 million because there's no discount or

premium on the bonds, no other initial cost to account for.

My interest payable day one will be 100,000.

I've received that from the investor.

It's actually interest payable that we will account for in the dates.

So again, this problem is structured to be as simple as possible,

with no premium discount or debt issuance cost.

But you will see this is in accounting problems sometimes.

You probably won't see it much in the real world.

But again, we'll take a look at the journal entry

when interim financial statements are prepared and when they are not prepared.

And we'll look first at the situation where no interim

financial statements are prepared.

So on June 30th, when I make my payment of 300,000,

200,000 of it, the amounts for March,

April, May, and June will be interest expense.

The amount that I received from the investor which is attributable really to

January and February, will reverse the payable that I originally entered.

So the interest expense is reduced, the cash is the same,

I reverse the payable that I received earlier.

But if I prepare interim financial statements, it's very similar.

Now March 31st, I would have interest expense of 50,000.

Where did I get the 50,000 from?

Well, it's one month's worth, 6% times 30 over 360 times $10 million.

This is the final month of the quarter.

Remember these were issued March 1st, so

there was two months interest already accrued.

And we recognize a $100,000 interest payable.

Now we're going to increase the interest payable for

another $50,000 to represent the total interest for

the quarter, which is 150,000 total.

On the payable, 50,000 of expense for

the quarter because the bonds were only outstanding one month.

On June 30th, now the bonds have been outstanding for the entire quarter.

So we'll have interest expense of $150,000 for the quarter,

but a cash payment of $300,000 according to the bond indenture.

And we'll reverse out the interest payable,

which was the amount which consists of $100,000

that we collected when the bonds were issued.

And the 50,000 we accrued at the end of the first quarter at March 31st.

So pretty basic journal entries, I know it's a little simple.

Don't worry we'll get more complicated later.

The extinguishment at the due date exactly the same.

The bonds payable at its face amount in cash.

So at this point, we've increased the complexity just a tiny bit to show what

happens when bonds are issued between interstates, a very common situation.

We'll continue this again by adding more layers of complexity

as we go forward in the course.

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