Welcome to this review lesson.
We're going to look back at long-term debt.
Now, we talked there about installment loans and bonds.
The periodic payments of principal and interest that are over the term of the loan.
They're all very similar. What's the difference?
Well, installment loans are usually to a single party or maybe a syndicate.
But bonds are often broken up,
so that you can have multiple bond holders and it allows
the lenders to spend their risk over multiple lenders,
and it also allows the borrower to often
raise more money than they could directly with just a loan.
We talked about common types of bonds.
Convertible debt, zero coupon bonds
and how you would have to determine an effective interest rate,
index debt, perpetual debt, increasing rate debt.
We talked about using the effective interest rate in order to recognize interest expense.
This is the rate of return implicit in the loan.
The contractual interest rate adjusted for
any net deferred loan fees or cross premium, or discount.
Talk about discount, means that the cash proceeds are
less than the face amount of the bonds,
and the effective interest rate therefore is higher.
Talk about premium.
Premium means that cash proceeds are greater than the face amount of the bonds,
and the effective interest rate therefore is lower.
We talked about debt issuance costs.
These are incremental costs that are incurred in order to issue debt,
they were previously sometimes
capitalized and accounted for as if they were a separate asset,
but FASB recently changed that.
So now, they'll be viewed as a decrease in the premium or an increase in the discount.
And we illustrated this in our discussion of the accounting for a discount.
Now subsequently, the bond premium or discount is
amortized to provide a constant effective interest rate.
And the way you do that,
you have your effective rate and for each period,
the interest expense is going to be that effective rate times the carrying value.
And then the difference between the cash paid and
the interest expense is the amortization of the premium or discount.
Now, you can use other methods if the results are not materially different,
say, if the premium or discount is very, very small.
The premium or discount can be amortized straight-line if the difference is immaterial.
And then finally, in this lesson,
we talked about the fair value option which permits all entities to choose to measure
eligible items at fair value as specified election dates and it can be applied to debt.
There are peculiar rules that apply to that including the fact that
some of the change in the fair value will be recognized in other comprehensive income.
So that concludes the first part of our discussion about bonds and long terms debt.
We'll continue in the next lesson with part two.