UAL2-U2-L02 · University Accounting Level 2
Bonds and long-term debt
Learning goals
- Price a bond from coupon and market yield.
- Build an effective-interest amortization schedule.
- Record issuance, interest, extinguishment, and current portions of debt.
Prerequisite check
Bond price equals the present value of coupon payments plus the present value of principal. If market yield exceeds coupon rate, price is below face value because the contractual cash interest is relatively unattractive.
Vocabulary
- Face value: principal repaid at maturity.
- Coupon rate: rate determining contractual cash interest.
- Market yield/effective rate: return used to price and recognize interest.
- Debt issuance cost: incremental transaction cost treated according to the applicable framework.
- Extinguishment: derecognition when an obligation is paid, cancelled, or expires.
Core idea
Initial carrying amount reflects present value at the effective rate. Each period, interest expense equals opening carrying amount times effective rate; the difference between expense and cash coupon changes carrying amount toward face value.
Why this treatment makes sense
The coupon alone does not measure borrowing cost when debt is issued at a discount or premium. Effective interest produces a constant periodic return on the outstanding carrying amount and makes financing economics visible.
A repeatable method
- Convert annual coupon and yield to the payment-period rates.
- Count payment periods correctly.
- Price coupon annuity and principal single sum.
- Record proceeds net/gross with transaction costs per the stated framework.
- Calculate effective interest on opening carrying amount.
- Compare with cash coupon to amortize discount or premium.
- Reconcile final carrying amount to face and account for settlement.
Worked example
On January 1, Boreal Transit issues $200,000 five-year bonds paying 4% annually when market yield is 6%. Given PV annuity factor 4.21236 and PV of $1 factor 0.74726:
Price = $8,000 × 4.21236 + $200,000 × 0.74726 = $33,698.88 + $149,452 = $183,150.88.
| Year | Opening | Interest at 6% | Cash coupon | Discount amortized | Closing |
|---|---|---|---|---|---|
| 1 | $183,150.88 | $10,989.05 | $8,000 | $2,989.05 | $186,139.93 |
| 2 | $186,139.93 | $11,168.40 | $8,000 | $3,168.40 | $189,308.33 |
Issue: debit Cash $183,150.88; credit Bonds Payable/carrying amount $183,150.88. Year 1: debit Interest Expense $10,989.05; credit Cash $8,000 and Bonds Payable $2,989.05. Continue until carrying amount reaches $200,000, adjusting final rounding.
Journal, ledger, and statement connection
The debt ledger plus schedule supports the statement liability and interest expense. The next twelve months' principal is current when due under presentation rules; note disclosures show maturity timing, rates, collateral, covenants, and liquidity risk.
Common mistakes
- Using the annual rate with semiannual periods without conversion.
- Calculating effective interest on face value.
- Adding discount amortization in a premium schedule.
- Reporting all debt as non-current because original maturity exceeded one year.
Guided practice
A $100,000 bond opens at $96,000, effective annual rate 7%, and pays $5,000 coupon. Interest expense $6,720; discount amortization $1,720; closing carrying amount $97,720.
Independent practice
Level 1 — direction: State whether a 5% coupon bond issued when yield is 4% sells at premium or discount.
Level 2 — schedule: Opening carrying amount $310,000, effective semiannual rate 3%, cash coupon $8,000. Calculate interest, amortization, and closing carrying amount.
Level 3 — extinguishment: Debt carrying amount $148,000 is repurchased for $151,500. Record the result, ignoring transaction costs.
Self-check and solutions
Level 1: Premium, because contractual cash interest exceeds the market return required.
Level 2: Interest $9,300; because cash is $8,000, discount amortization $1,300; closing $311,300.
Level 3: Debit debt $148,000 and loss on extinguishment $3,500; credit cash $151,500. Confirm no separate unamortized balance is double-counted.
Retrieval practice
- Which rate calculates cash coupon?
- Which rate calculates interest expense?
- Where should a discount carrying amount end?
Answers: coupon; effective yield; face value at maturity.
Exam-style application
Price a bond using supplied factors, complete three schedule rows, prepare entries, and explain how an approaching covenant threshold affects disclosure but not the arithmetic.
Lesson summary
Bond accounting converts financing terms into present value and a constant effective return, then links the schedule to entries, maturity presentation, and covenant notes.