Sunday, July 5, 2009

the bond itself

Bonds will have a stated amount (face value), a stated interest rate, a maturity date and information about when interest is paid. The maturity date is the date on which the issuer will "retire' the bond by paying the face amount of the bond to the bondholder. Below is an example of basic bond information.
-face value $1000
-interest rate 8%
-Issue date January 1,2001
-Maturity Date December 31,2001
-Interest is paid annually on December 31
From this information, we can determine all of the amounts that the issuer will pay to the holder of the bond over the life of the bond. We have already mentioned that on the maturity date the issuer will pay the face amount ($1,000 in this case) to the bondholder. The cash that will be paid as interest every December 31st is also determinable from this information. The cash paid as interest is calculated as the face value multiplied by the stated rate of interest.
For interest in this bond example provided above, the issuer of the bond will pay $80 in cash as interest to the purchaser of the bond every December 31st from December 31, 2001, until December 31, 2001.
On December 31, 2011 (the maturity date), not only will the owner of the bond receive the $80 interest payment, but s\he will also receive $1000, which is the face value of the bond on that date.
The accounting for bonds is easier if we understand what happens over the life of the bond. When a company issues a bond it is in a sense simply borrowing money from someone else, and this money will need to be repaid in the future. Whenever a company borrows money, it should recognize a liability for the amount borrowed. Also, each period, it will need to recognize some amount of interest expense related to the amount that it has, in effect, borrowed. The main issues with bonds relate to the calculation of the selling price (or issuance price) of the bond and the calculation of the amount of interest expense that needs to be recognized each period.
However, before looking at the accounting for the bond, we will look again at the cash flows related to the bond itself. This show we the accounting issues that we need to cover. The three main cash flows are the sale of the bond, interest and payment of the face value at maturity.

No comments: