Accounting: The Language of Business (Part 94)

For generations of Hong Kongers, the only means of upward mobility and the only way to meaningfully contribute to society have been to obtain a respectable university degree (preferably in business administration) and a professional accreditation (in finance, accounting, law or medicine).

Joshua Wong

Bonds Payable and Investments in Bonds (Part E)

by

Charles Lamson 

Corporation Balance Sheet

In previous posts, we illustrated the income statement and retained earnings statement for a corporation. The consolidated balance sheet in Exhibit 5 illustrates the presentation of many of the items discussed in preceding posts. These items include bond sinking funds, investments in bonds, goodwill, deferred income taxes, bonds payable and unamortized discount, and minority interest in subsidiaries.

EXHIBIT 5 Balance Sheet of a Corporation

Balance Sheet Presentation of Bonds Payable 

In Exhibit 5, Escoe Corporation bonds payable are reported as long-term liabilities. If there were two or more bond issues, the details of each would be reported on the balance sheet or in a supporting schedule or note. Separate accounts are normally maintained for each bond issue.

When the balance sheet date is within one year of the maturity date of the bonds, the bonds may be classified as a current liability. This would be the case if the bonds are to be paid out of current assets. If the bonds are are to be paid from a sinking fund or if they are to be refinanced with another bond issue, they should remain in the non-current category. In this case, the details of the retirement of the bonds are normally disclosed in a note to the financial statements.

The balance in Escoe's discount on bonds payable account is reported as a deduction from the bonds payable. Conversely, the balance in a bond premium account would be reported as an addition to the related bonds payable. Either on the face of the financial statements or in accompanying notes, a description of the bonds (terms, due date, and effective interest rate) and other relevant information such as sinking fund requirements should be disclosed. Finally, the market (fair) value of the bonds payable should also be disclosed.

Balance Sheet Presentation of Bond Investments

Investments in bonds or other debt securities that management intends to hold to their maturity are called held-to-maturity securities. Such securities are classified as long-term investments under the caption Investments. These Investments are recorded at their cost less any amortized premium or plus any amortized discount. In addition, the market (fair) value of the bond investments should be disclosed, either on the face of the balance sheet or in an accompanying note.

Financial Analysis and Interpretation

Some corporations, such as railroads and public utilities, have a high ratio of debt to stockholders' equity. For such corporations, analysts often assess the relative risk of the debt holders in terms of the number of times the interest charges are earned during the year. The higher the ratio, the greater the chance that interest payments will continue to be made if earnings decrease [Statement of Financial Accounting Standards No. 129, "Disclosure Information About Capital Structure." Financial Accounting Standards Board (1997)].

The amount available to make interest payments is not affected by taxes on income. This is because interest is deductible in determining taxable income. To illustrate, the following data were taken from the 2002 annual report of Briggs & Stratton Corporation:

The number of times interest charges are earned, 2.81, is calculated below.

The number of times interest charges are earned indicates that the debt holders of Briggs & Stratton have adequate protection against the potential drop in earnings jeopardizing their receipt of interest payments. However, a final assessment should include a review of trends of past years and a comparison with industry averages. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 616-618*

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