Study Guide: CFA Level 1

Liabilities - Effects Of Debt Issuance

Bonds Issued at Par - Effects On:
  • Income statement - The income statement will include an interest expense equal to the bond's coupon payment attributable to the specified accounting period.
  • Balance sheet - The balance sheet will include at all times a long-term liability equal to the face value of the bond until its maturity or redemption.
  • Cash flow statement - Going forward, cash flow from operations will include the interest expense recorded on the income statement. As of the issuing date, the company will account in cash flow from financing the total amount received for the bond.
Bonds Issued at a Premium - Effect On:
  • Income statement - The income statement will include an interest expense equal to the bond's coupon payment minus the amortized portion of the premium received during the specified accounting period.
  • Balance sheet - The balance sheet will include at all times a long-term liability equal to its carrying value. At initiation the carrying value will be equal to the face value of the bond plus the total unamortized premium. Every year the bond value recorded on the balance sheet will be reduced until the bond comes to maturity or is redeemed and the bond value displayed on the balance eventually reaches the bond's original face value.
  • Cash flow statement - Going forward, cash flow from operations will include the actual coupon paid to the debt holder during the specified accounting period. Since this is a bond that was sold at a premium, it is paying out a larger coupon than is currently stated as an interest expense on the income statement. As a result, CFO will be understated relative to that of a company that sold its bond at par. The amortized portion of the bond premium will be included in cash flow from financing. This will cause the reported cash flow from financing to be overstated relative to that of a company that sold its bond at par.
Advertisment - ExamPrep continues below.

Bonds Issued at a Discount - Effect On:
  • Income statement - The income statement will include an interest expense equal to the bond's coupon payment plus the amortized portion of the discount received during the specified accounting period.
  • Balance sheet - The balance sheet will include at all times a long-term liability equal to its carrying value. At initiation the carrying value will be equal to the face value of the bond minus the total unamortized discount. Every year the bond value recorded on the balance sheet will be increased until the bond comes to maturity and the bond value displayed on the balance is equal to the bond's face value.
  • Cash flow statement - Going forward, cash flow from operations will include the actual coupon paid to the debt holder during the specified accounting period. Since this is a bond that was sold at a discount, it is paying out a smaller coupon than is currently stated as an interest expense on the income statement. As a result CFO will be overstated relative to that of a company that sold its bond at par. The amortized portion of the bond discount will be included in cash flow from financing. This will cause the reported cash flow from financing to be understated relative to that of a company that sold its bond at par.
Computation
Company ABC issues a $1m bond that will pay a 10% semiannual (coupon) for three years; the company will generate $500,000 EBITDA over the next three years. Contract the effect if market rate at the time of issuance was 10%, 11% and 9%. (Straight-line depreciation is used for premiums and discounts). Taxes are not considered.

Opening balance sheet:



Next: Implications Of Debt Issuance »
by

Investopedia.com

Investopedia.com
No writer biography is available.
Sponsored Links
Related Articles
Partner Links