Long-term Investment is expected to be collected more than one or two years of the operating cycle or accounting period. A long-term investment is both equity and debt securities. The Following primary characteristics of long-term debt security are:
- Obligation to transfer assets or services to specified entities at a determinable future date.
- The obligation was caused by a transaction or event that has already occurred.
- The enforceable contract between the parties.
Typical long-term debt securities include long-term notes payable, mortgages payable, pension liabilities, lease liabilities, and bonds payable.
Accounting for Long-term Notes and Mortgages
Accounting for long-term notes and mortgages involves two different situations:
1. The stated and yield Merest rates are the same
This situation does not involve any discount or premium on the debt because the stated and yield rates are the same.
2. The stated and yield interest rates are different.
This situation involves a discount or premium on the debt because the stated and yield rates differ. The two rates will be different because;
- the market or going rate at the level of risk involved in the debt is higher or lower than the stated rate, or
- the note itself specifies conditions that produce this effect.
In this situation, the appropriate yield rate is not specified.
Bond
A bond is a legal document that represents a formal promise to pay: (a) a specified principal amount at a designated date in the future, and (b) periodic interest on (the principal al the interest rate per period stated on the bond.
Classification of Bonds
Bonds may be classified in various ways as follows:
- The character of the issuing corporation: The issuer may be a private corporation issuing industrial the issuer may also be a public corporation issuing municipal or government bonds.
- Purpose of issue: Purchase money bonds are issued in full or part payment for the property. Refunding bonds are issued to retire existing obligations and may have the same security as the retired.
- Payment of interest: Bonds are sometimes classified according to the amount of interest. Ordinan bonds entitle the investor to receive cash interest. Income bonds differ from ordinary bonds in that the payment of interest each period on income bonds depends on the issuer’s earnings.
- Maturity of Ordinary principal bonds: The maturity of Ordinary principal bonds matures at a single specified date. Convertible bonds give the issuer the option to retire them at a stated price before maturity date.
Calculation of the Present value of the bond
The price of the bond is the present value of all of its excepted net future cash inflows discounted at the market rate of interest.
The present value of a bond is the sum of two present-value amounts
- The present value of its face value plus,
- The present value of the scries of future cash interest payments.
We can calculate the present value of the bond in the following way:
Let’s see the debit and credit entries for the Issuer of the bond.
Transaction: The bond issue was sold (and purchased) at par
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Cash | X | |
| Bonds Payable | X |
Transaction: The bond issue was sold (and purchased) at a discount
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Cash | X | |
| Discount on Bonds | X | |
| Bonds Payable | X |
Transaction: The bond issue was sold (and purchased) at a premium
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Cash | X | |
| Premium on Bonds | X | |
| Bonds Payable | X |
Transaction: The bond sold (and purchased) between interest dates at a discount
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Cash | X | |
| Discount on Bonds | X | |
| Bonds Payable | X | |
| Interest Expense | X |
Transaction: The bond sold (and purchased) between interest dates at a premium
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Cash | X | |
| Premium on Bonds | X | |
| Bonds Payable | X | |
| Interest Expense | X |
Please note that the table assumes a simplified scenario and doesn’t include all possible accounts that might be affected by these transactions. The entries provided are based on the given information. It’s important to consult with a professional accountant or refer to specific accounting guidelines for accurate and complete entries.
Let’s see the debit and credit entries for the Investor of the bond.
Transaction: The bond issue was sold (and purchased) at par
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Bonds Payable | X | |
| Cash | X |
Transaction: The bond issue was sold (and purchased) at a discount
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Bonds Payable | X | |
| Discount on Bonds | X | |
| Cash | X |
Transaction: The bond issue was sold (and purchased) at a premium
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Bonds Payable | X | |
| Premium on Bonds | X | |
| Cash | X |
Transaction: The bond sold (and purchased) between interest dates at a discount
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Bonds Payable | X | |
| Discount on Bonds | X | |
| Interest Revenue | X | |
| Cash | X |
Transaction: The bond sold (and purchased) between interest dates at a premium
| Account | Debit (Increase) | Credit (Decrease) |
|---|---|---|
| Bonds Payable | X | |
| Premium on Bonds | X | |
| Interest Revenue | X | |
| Cash | X |
Similar to the previous response, please note that this table assumes a simplified scenario and doesn’t include all possible accounts that might be affected by these transactions.
The entries provided are based on the given information. It’s always advisable to consult with a professional accountant or refer to specific accounting guidelines for accurate and complete entries.
| Issuer | Investor |
|---|---|
| The bond issue was sold (and purchased) per | |
| Cash – Credit Bonds Payable – Debit | Cash – Debit Bonds Payable – Credit |
| The bond issue was sold (and purchased) at discount | |
| Cash – Credit Discount on bond – Debit Bonds Payable – Credit | Bonds Payable – Credit Discount on Bonds – Debit Cash – Debit |
| The bond issue was sold (and purchased) at Premium | |
| Cash – Credit Premium on bond – Debit Bonds Payable – Credit | Bonds Payable – Credit Premium on Bonds – Debit Cash – Debit |
| The bond sold (and purchased) between interest date at a Discount | |
| Cash – Credit Discount on Bonds – Debit Bonds Payable – Credit Interest Expense – Debit | Bonds Payable – Credit Discount on Bonds – Debit Interest Revenue – Debit Cash – Debit |
| The bond sold (and purchased) between interest date at a Premium | |
| Cash – Credit Premium on Bonds – Debit Bonds Payable – Credit Interest Expense – Credit | Bonds Payable – Credit Premium on Bonds – Debit Interest Revenue – Credit Cash – Debit |
Extinguishment
Debt may be extinguished by
- direct cash payments to the creditors;
- exercise of a call privilege by the issuer,
- Purchase in the open market by the issuer or funding- the retirement of old debt by issuing new debt.
Exercise of Call Privilege by Issuer
Extinguishment b\ call almost always is required to be on an interest date. The amortization of any discount or premium and bond issue costs will be up to date, and there will be no accrued interest. II the call is not on an interest date, all accounts must be updated with accrual and amortization entries.
Purchase in the Open Market by Issuer
Borrowers sometimes extinguish debt early by purchasing their debt securities in the open market. Such open-market purchases usually are not on an interest date.
Therefore, before recording the extinguishment, any discount or premium and bond issue cost must be amortized. Also, interest must be accrued from the last interest date to the date of the open-market purchase.
Refunding Old Debt by Issuing New Debt
Refunding old debt by issuing new debt may involve two different situations: (a) Issuance of new debt in direct exchange for the old debt- In this situation, the old creditors become the new creditors. T his situation does not often occur because of settlement agreements that must be reached between the debtor and creditors involved.
(b)Issuance of new debt to obtain the cash needed to pay the creditors before maturity date- In this situation: the old paid off, and a new set of creditors lake their place.