Bonds and bonds payable are most frequently classified as long-term liabilities on the balance sheet. A bond is a fixed income investment that allows an investor to take a loan and borrow the funds for a defined period of time at either a variable or a fixed rate. Common terms that you will need to know for the CPA exam consist of:
Bond indenture – Bond indentures are documents that are used to describe the agreement between the borrower and the lender.
Face value – Also referred to as “par value”, this is the dollar amount of the bond and the basis for which periodic interest payments are made.
Market interest rate – The market interest rate is the rate that interest is actually earned by the bondholder.
Stated interest rate – The stated interest rate is the interest that is paid to the investors in cash. This is also referred to as the nominal interest rate.
Discount – Discount is the amount if the market rate is higher than the stated rate. This will occur if the bond sells for less than the face amount. Discounts will be amortized over the life of the bond. The amount amortized will increase the interest expense each period.
Premium – Premium is the amount if the market rate is lower than the stated rate. This will occur if the investor pays more than face value. Unamortized bond premiums will be presented in the financial statements as an addition to the face value of the bond. As the bond is amortized the premium will decrease.
Unamortized premium/discount – Often examiners will ask a candidate to calculate the “unamortized bond premium or discount”. Note that this amount is referring to the amount of the bond premium/discount that is yet to be amortized.
There are various types of bonds that you might see on the CPA exam.
Collateral trust bonds – A collateral trust bond is a bond that is secured by a financial asset – such as stock or other bonds that is deposited and held by a trustee for the holders of the bond.
Convertible bonds – A convertible bond is a fixed-income debt security that yields interest payments but can be converted into a predetermined number of common stock or equity shares. The conversion from the bond to stock can be done at certain times during the bond’s life and is usually at the discretion of the bondholder.
Debenture bonds – A debenture is a type of debt instrument unsecured by collateral. Since debentures have no collateral backing, debentures must rely on the creditworthiness and reputation of the issuer for support. Both corporations and governments frequently issue debentures to raise capital or funds.
Mortgage bonds – A mortgage bond is a bond secured by a mortgage or pool of mortgages. These bonds are typically backed by real estate holdings and real property such as equipment.
Term bonds – A term bond refers to bonds from the same issue that share the same maturity dates. In effect, term bonds mature on a specific date in the future and the bond face value must be repaid to the bondholder on that date.
Serial bonds – A serial bond is a bond issue that is structured so that a portion of the outstanding bonds mature at regular intervals until all of the bonds have matured.
Participating bonds – A bond which allows the holder to receive a guaranteed minimum rate plus extra coupon payments up to a specific level if the issuer would manage to achieve a preset level of income or profits. This bond, thus, entitles the holder additional benefits beyond its fixed rate of interest.
Income bonds – An income bond is a type of debt security in which only the face value of the bond is promised to be paid to the investor, with any coupon payments paid only if the issuing company has enough earnings to pay for the coupon payment.
Zero coupon bonds – A zero coupon bond is a bond that is issued at a deep discount to its face value but pays no interest.
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