Question

The case can be found in the link "end of chapter materials" in the Chapter 14 reading link under Required Resources.

Copied below:

CA14-1.  

(Bond Theory: Balance Sheet Presentations, Interest Rate, Premium)

On January 1, 2017, Nichols Company issued for $1,085,800 its 20-year, 11% bonds that have a maturity value of $1,000,000 and pay interest semiannually on January 1 and July 1. The following are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date.

1.	Bonds payable (maturing January 1, 2037)	$1,000,000
	Unamortized premium on bonds payable	85,800
	Total bond liability	$1,085,800
2.	Bonds payable—principal (face value $1,000,000 maturing January 1, 2037)	$  142,050a
	Bonds payable—interest (semiannual payment $55,000)	943,750b
	Total bond liability	$1,085,800
3.	Bonds payable—principal (maturing January 1, 2037)	$1,000,000
	Bonds payable—interest ($55,000 per period for 40 periods)	2,200,000
	Total bond liability	$3,200,000

Instructions

(a)  

Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.

(b)  

Explain why investors would pay $1,085,800 for bonds that have a maturity value of only $1,000,000.

(c)  Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose:

1.The coupon or nominal rate.

2.The effective or yield rate at date of issue.

(d)  

If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of issue be affected by an increase or a decrease in the market rate of interest?

Answer 1

(a) 1. The first presentation is quite good as considered the GAAPs as this entatils the presentation of the total outstanding as regards to the Bond that is known at the time of issue of the same. This liability is owed at the time of the issue of the bond as per the terms of issue and certain.

2. This is the way of recognition of any financial liability recognition in the financial statements. This is taken to the balance sheet at their present value of the obligation.

3. Here the interest payments are also considered al liability but the same are still not due so we can,t recognise them at this time for accrual and maching concepts.

(b) The investor might pay the excess sum because the interest rate is as good as 11% that might be more that other bonds in the market and the yield of the bond is also higher in comparision.

(c) Coupon rate : this can be used for discounting when the bond is issued at par and payable at par.

   Yield rate : this is used most for any bond discounting as this is quite real as there are bonds that normally have different issue and maturity value, where this rate is based on the IRR.

(d) while in case of increase in the market rate of interest, the value of the bond will decrease or say it would se discount and at premium in reverse case.