April 4, 2024

20 2 Statement of Cash Flows: Indirect Method Review Intermediate Financial Accounting 2

Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles. Using debt (such as loans and bonds) to acquire more assets than would be possible by using only owners’ funds. A series of equal amounts occurring at the end of each equal time interval.

Summary of the Effect of Market Interest Rates on a Bond’s Issue Price

On issuance, a premium bond will create a “premium on bonds payable” balance. The actual interest paid out (also known as the coupon) will be higher than the expense. If a company issues stocks or bonds for cash and then pays off the debt, the transaction is reported in the financing section of the statement of cash flows. The issuance cost incurred will be accounted for based on the jurisdiction of the organization issuing the bond. If a governmental entity accounting under GASB issues the bond, the issuance cost will be expensed as incurred on the statement of net activities. If an organization following FASB standards issues the bond, the total issuance cost will be deferred and amortized over the life of the bond.

When the company paid off bonds payable, it will pay cash to the bondholders. So on the cash flow statement, they have to record cash outflow based on the amount of bonds decrease. As we can see in the journal entry above, the issuing of bonds will increase the cash inflow as the company receive it from investors. On the other hand, when company paid off the bonds, there will be a cash decrease on the company balance sheet. When it comes to the cash flow statement, companies usually report on three components.

The operating activities section of the statement of cash flows appears first. It may be prepared in one of two ways, using either the indirect or the direct method. Although information presented in the operating activities section is different, both methods yield the same cash flows from operating activities amount. The indirect method is more popular because the information needed to prepare the section is readily available on the income statement and balance sheet.

To illustrate the discount on bonds payable, let’s assume that in early December 2023 a corporation prepares a 9% $100,000 bond dated January 1, 2024.
While this method is easier to apply, it does not account for the changing carrying amount of the bond, potentially leading to discrepancies in the interest expense recognized.
Next, let’s assume that just prior to offering the bond to investors on January 1, the market interest rate for this bond increases to 10%.
On the same day you pay your cell phone bill and car insurance payment for a total of $210.
Like issuance of bonds, companies must report the transaction in both the financial statements.
Note that under the effective interest rate method the interest expense for each year is increasing as the book value of the bond increases.

Issuance costs

The following table summarizes the effect of the change in the market interest rate on an existing $100,000 bond with a stated interest rate of 9% and maturing in 5 years. It is reasonable that a bond promising to pay 9% interest will sell for less than its face value when the market is expecting to earn 10% interest. In other words, the 9% $100,000 bond will be paying $500 less semiannually than the bond market is expecting ($4,500 vs. $5,000).

The discount of $3,851 is treated as an additional interest expense over the life of the bonds. When the same amount of bond discount is recorded each year, it is referred to as straight-line amortization. In this example, the straight-line amortization would be $770.20 ($3,851 divided by the 5-year life of the bond). Let’s illustrate this scenario with a corporation preparing to issue a 9% $100,000 bond dated January 1, 2024. The bond will mature in 5 years and requires interest payments on June 30 and December 31 of each year until December 31, 2028.

This can be done with computer software, a financial calculator, or a present value of an ordinary annuity (PVOA) table. Let’s assume that just prior to selling the bond on January how to start a virtual bookkeeping business in 5 simple steps 1, the market interest rate for this bond drops to 8%. Rather than changing the bond’s stated interest rate to 8%, the corporation proceeds to issue the 9% bond on January 1, 2024.

Principal Amount

Treasury bonds, which come in various maturities such as T-bills (short-term), T-notes (medium-term), and T-bonds (long-term). Interest on government bonds is typically exempt from state and local taxes, making them an attractive option for risk-averse investors. The stability and reliability of government bonds make them a cornerstone in many investment portfolios, particularly for those seeking to preserve capital and generate steady income. This guide aims to provide a comprehensive overview of bonds payable, delving into their various types, accounting treatments, and implications on financial statements. Bonds payable represent a critical component of corporate and governmental financing strategies.

Bonds payable are the financial instrument that company uses to issue to get cash from investors.
An even more peculiar and counterintuitive presentation of cash flowsresults upon the retirement of bonded debt issued at a premium.
The transaction will reverse the bonds payable from the balance sheet and record cash paid to the bondholders.
We will use the Present Value of 1 Table (PV of 1 Table) for our calculations.
Phantom’s most recent balance sheet, income statement, and other important information for 2012 are presented in the following.
However, the income statement, retained earnings statement, and balance sheet do not directly track or report the flow of cash.
This column represents the number of identical payments and periods in the ordinary annuity.

After issuance, ABC Co. incurs an interest expense of $5,000 on these bonds. Therefore, what is the matching principle and why is it important the transaction falls under the cash flows from the financing activities component. The balance sheet reports the assets, liabilities, and owner’s (stockholders’) equity at a specific point in time, such as December 31. The balance sheet is also referred to as the Statement of Financial Position.

Bond Issuance and Retirement

Therefore, companies must calculate the cash outflows relating to interest payments and decrease them under financing activities. However, when companies acquire finance through bonds or repay them, this statement will experience an impact. Similarly, any interest payments made to bondholders also affect the cash flow statement. These financial instruments are crucial for businesses seeking to finance large projects, such as expansion or infrastructure development, without diluting ownership through equity. Understanding bonds payable is essential for accounting professionals and investors to assess a company’s financial health and debt obligations. Bonds payable are a form of long term debt usually issued by corporations, hospitals, and governments.

In the case of a discount, an investor the difference between net 30 and due in 30 days may pay less than the face value of the bonds when the rate that is stated on the face of the bond is lower than the interest rate in the market at that time. In this situation, investors earn a larger return on their investment because of the purchase at a reduced price. Calculate net cash flows from investing activities amount by deducting cash outflows from cash inflows.

Direct Method

When issued, the bonds are entered at their face value, with adjustments made for any premiums or discounts and accrued interest over time. Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The present value (and the market value) of this bond depends on the market interest rate at the time of the calculation. The market interest rate is used to discount both the bond’s future interest payments and the principal payment occurring on the maturity date. To illustrate the discount on bonds payable, let’s assume that in early December 2023 a corporation prepares a 9% $100,000 bond dated January 1, 2024. The interest payments of $4,500 ($100,000 x 9% x 6/12) will be required on each June 30 and December 31 until the bond matures on December 31, 2028.