Present Value - Accounting Examples (for excel download: PV2)

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Example 2:  Bond Issuance   (Preview for Chapter 13!)
  • XYZ Company is issuing bonds with a face value of $100,000.  The bonds pay 10% interest and mature (the principal will be paid) in five years.  Interest is paid semi-annually.
  • How should the bonds be recorded on the balance sheet?  That depends on how much money the company actually receives for the bonds.  And that, in turn, depends on how much investors (the market) want to earn on an investment of this type and risk class.  
  • From an investor's point of view a bond is an investment opportunity consisting of the following: (in this specific case)
    • a promise to pay $5,000 ten times (twice a year for five years)
    • a promise to pay $ 100,000 at the end of five years.
  • Then question then becomes:  How much are investors willing to pay now for these two promised future cashflows?

This is an example of a combination present value of a single sum and an annuity
Step one (regardless of required rate of return - discount rate) determine the amount of semi-annual interest payments:  

Principal

coupon

Interest

semi-annual

rate

payment

payment

$100,000

10%

$10,000

$5,000
Case 1:  Bonds are issued at par (face value):
  • If investors want to earn 10%, payments are discounted at 5%:
 Calculation:

100000

PV(5%, 10)

0.61391

$61,391

5000

Pva(5%,10)

7.72173

$38,609

$100,000
To record the bond issue:
  • dr. cash      $100,000
    • cr. bonds payable    $100,000
Case 2: Bonds are issued at a discount:
  • If investors want to earn 12%, payments are discounted at 5%:
 Calculation:

100000

PV(6%, 10)

0.55839

$55,839

5000

Pva(6%,10)

7.36009

$36,800

$92,639
To record the bond issue:
  • dr. cash          $92,639
  • dr. discount      $   7,361
    • cr. bonds payable    $100,000
Case 3: Bonds are issued at a premium:
  • If investors want to earn 8%, payments are discounted at 4%:
 Calculation:

100000

PV(6%, 10)

0.67556

$67,556

5000

Pva(6%,10)

8.1109

$40,555

$108,111
To record the bond issue:
  • dr. cash          $108,111
    • cr. bonds payable    $100,000
    • cr. premium               $    8,111
What happens to the discount or premium?  They are amortized and increase (decrease) semi-annual interest expense.  (No need to worry about that now, there is Chapter 13 after all!)

Return to: home| basic PV  | pv & accounting | annuities I  |  annuities II | Examples: 1 - PV of Note Receivable | 2 - Issuance of Bond | 3: Cash or Note Payable? | 4 A: Buying a car - interest rate? |4 B: Buying a car - payments: | Quizz Practice quizz (from an old text book, but still working)