Page 619 - Accounting Principles (A Business Perspective)

15. Long-term financing: Bonds

Effective interest rate method (interest method) A procedure for calculating periodic interest expense
(or revenue) in which the first period's interest is computed by multiplying the carrying value of bonds
payable (bond investments) by the market rate of interest at the issue date. The difference between computed
interest expense (revenue) and the interest paid (received), based on the contract rate times face value, is the
discount or premium amortized for the period. Computations for subsequent periods are based on the
carrying value at the beginning of the period.
Face value Principal amount of a bond.
Favorable financial leverage An increase in EPS and the rate of return on stockholders' equity resulting
from earning a higher rate of return on borrowed funds than the fixed cost of such funds. Unfavorable
financial leverage results when the cost of borrowed funds exceeds the income they generate, resulting in
decreased income to stockholders.
Future value or worth The amount to which a sum of money invested today will grow during a stated
period of time at a specified interest rate.
Interest method See effective interest rate method.
Junk bonds High-interest rate, high-risk bonds; many were issued in the 1980s to finance corporate
restructurings.
Market interest rate The minimum rate of interest investors will accept on bonds of a particular risk
category. Also called effective rate or yield.
Mortgage A legal claim (lien) on specific property that gives the bondholder the right to possess the pledged
property if the company fails to make required payments. A bond secured by a mortgage is called a mortgage
bond.
Premium (on bonds) Amount a bond sells for above its face value.
Present value The current worth of a future cash receipt(s); computed by discounting future receipts at a
stipulated interest rate.
Registered bond A bond with the owner's name on the bond certificate and in the register of bond owners
kept by the bond issuer or its agent, the registrar.
Secured bond A bond for which a company has pledged specific property to ensure its payment.
Serial bonds Bonds in a given bond issue with maturities spread over several dates.
Simple interest Interest on principal only.
Sinking fund See Bond redemption fund.
Stock warrant A right that allows the bondholder to purchase shares of common stock at a fixed price for a
stated period of time. Warrants issued with long-term debt may be detachable or nondetachable.
Straight-line method of amortization A procedure that, when applied to bond discount or premium,
allocates an equal amount of discount or premium to each period in the life of a bond.
Term bond A bond that matures on the same date as all other bonds in a given bond issue.
Times interest earned ratio Income before interest and taxes (IBIT) divided by interest expense. In
complex situations, "operating income" is often used to represent IBIT.
Trading on the equity A company using its stockholders' equity as a basis for securing funds on which it
pays a fixed return.
Trustee Usually a bank or trust company appointed to represent the bondholders and to enforce the
provisions of the bond indenture against the issuer.
Underwriter An investment company or a banker that performs many tasks for the bond issuer in issuing.
bonds; may also guarantee the issuer a fixed price for the bonds.
Unfavorable financial leverage Results when the cost of borrowed funds exceeds the revenue they
generate; it is the reverse of favorable financial leverage.
Unregistered (bearer) bond Ownership transfers by physical delivery.
Unsecured bond A debenture bond, or simply a debenture.
Self-test
True-false
Indicate whether each of the following statements is true or false.
An unsecured bond is called a debenture bond.

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