Accounting For Long Term Investment

Accounting For Long Term Investment

Long-term Investment is expected to be collected more than one or two years of the operating cycle or accounting period. A long-term investment is both equity and debt securities. The Following primary characteristics of long-term debt security are:

  • Obligation to transfer assets or services to specified entities at a determinable future date.
  • The obligation was caused by a transaction or event that has already occurred.
  • The enforceable contract between the parties.

Typical long-term debt securities include long-term notes payable, mortgages payable, pension liabilities, lease liabilities, and bonds payable.

Accounting for Long-term Notes and Mortgages

Accounting for long-term notes and mortgages involves two different situations:

1. The stated and yield Merest rates are the same

This situation does not involve any discount or premium on the debt because the stated and yield rates are the same.

2. The stated and yield interest rates are different.

This situation involves a discount or premium on the debt because the stated and yield rates differ. The two rates will be different because;

In this situation, the appropriate yield rate is not specified.

Bond

A bond is a legal document that represents a formal promise to pay: (a) a specified principal amount at a designated date in the future, and (b) periodic interest on (the principal al the interest rate per period stated on the bond.

Classification of Bonds

Bonds may be classified in various ways as follows:

  • The character of the issuing corporation: The issuer may be a private corporation issuing industrial the issuer may also be a public corporation issuing municipal or government bonds.
  • Purpose of issue: Purchase money bonds are issued in full or part payment for the property. Refunding bonds are issued to retire existing obligations and may have the same security as the retired.
  • Payment of interest: Bonds are sometimes classified according to the amount of interest. Ordinan bonds entitle the investor to receive cash interest. Income bonds differ from ordinary bonds in that the payment of interest each period on income bonds depends on the issuer’s earnings.
  • Maturity of Ordinary principal bonds: The maturity of Ordinary principal bonds matures at a single specified date. Convertible bonds give the issuer the option to retire them at a stated price before maturity date.

Calculation of the Present value of the bond

The price of the bond is the present value of all of its excepted net future cash inflows discounted at the market rate of interest.

The present value of a bond is the sum of two present-value amounts

  1. The present value of its face value plus,
  2. The present value of the scries of future cash interest payments.

We can calculate the present value of the bond in the following way:

Let’s see the debit and credit entries for the Issuer of the bond.

Transaction: The bond issue was sold (and purchased) at par

AccountDebit (Increase)Credit (Decrease)
CashX
Bonds PayableX

Transaction: The bond issue was sold (and purchased) at a discount

AccountDebit (Increase)Credit (Decrease)
CashX
Discount on BondsX
Bonds PayableX

Transaction: The bond issue was sold (and purchased) at a premium

AccountDebit (Increase)Credit (Decrease)
CashX
Premium on BondsX
Bonds PayableX

Transaction: The bond sold (and purchased) between interest dates at a discount

AccountDebit (Increase)Credit (Decrease)
CashX
Discount on BondsX
Bonds PayableX
Interest ExpenseX

Transaction: The bond sold (and purchased) between interest dates at a premium

AccountDebit (Increase)Credit (Decrease)
CashX
Premium on BondsX
Bonds PayableX
Interest ExpenseX

Please note that the table assumes a simplified scenario and doesn’t include all possible accounts that might be affected by these transactions. The entries provided are based on the given information. It’s important to consult with a professional accountant or refer to specific accounting guidelines for accurate and complete entries.

Let’s see the debit and credit entries for the Investor of the bond.

Transaction: The bond issue was sold (and purchased) at par

AccountDebit (Increase)Credit (Decrease)
Bonds PayableX
CashX

Transaction: The bond issue was sold (and purchased) at a discount

AccountDebit (Increase)Credit (Decrease)
Bonds PayableX
Discount on BondsX
CashX

Transaction: The bond issue was sold (and purchased) at a premium

AccountDebit (Increase)Credit (Decrease)
Bonds PayableX
Premium on BondsX
CashX

Transaction: The bond sold (and purchased) between interest dates at a discount

AccountDebit (Increase)Credit (Decrease)
Bonds PayableX
Discount on BondsX
Interest RevenueX
CashX

Transaction: The bond sold (and purchased) between interest dates at a premium

AccountDebit (Increase)Credit (Decrease)
Bonds PayableX
Premium on BondsX
Interest RevenueX
CashX

Similar to the previous response, please note that this table assumes a simplified scenario and doesn’t include all possible accounts that might be affected by these transactions.

The entries provided are based on the given information. It’s always advisable to consult with a professional accountant or refer to specific accounting guidelines for accurate and complete entries.

IssuerInvestor
The bond issue was sold (and purchased) per
Cash – Credit
Bonds Payable – Debit
Cash – Debit
Bonds Payable – Credit
The bond issue was sold (and purchased) at discount
Cash – Credit
Discount on bond – Debit
Bonds Payable – Credit
Bonds Payable – Credit
Discount on Bonds – Debit
Cash – Debit
The bond issue was sold (and purchased) at Premium
Cash – Credit
Premium on bond – Debit
Bonds Payable – Credit
Bonds Payable – Credit
Premium on Bonds – Debit
Cash – Debit
The bond sold (and purchased) between interest date at a Discount
Cash – Credit
Discount on Bonds – Debit
Bonds Payable – Credit
Interest Expense – Debit
Bonds Payable – Credit
Discount on Bonds – Debit
Interest Revenue – Debit
Cash – Debit
The bond sold (and purchased) between interest date at a Premium
Cash – Credit
Premium on Bonds – Debit
Bonds Payable – Credit
Interest Expense – Credit
Bonds Payable – Credit
Premium on Bonds – Debit
Interest Revenue – Credit
Cash – Debit

Extinguishment

Debt may be extinguished by

  • direct cash payments to the creditors;
  • exercise of a call privilege by the issuer,
  • Purchase in the open market by the issuer or funding- the retirement of old debt by issuing new debt.

Exercise of Call Privilege by Issuer

Extinguishment b\ call almost always is required to be on an interest date. The amortization of any discount or premium and bond issue costs will be up to date, and there will be no accrued interest. II the call is not on an interest date, all accounts must be updated with accrual and amortization entries.

Purchase in the Open Market by Issuer

Borrowers sometimes extinguish debt early by purchasing their debt securities in the open market. Such open-market purchases usually are not on an interest date.

Therefore, before recording the extinguishment, any discount or premium and bond issue cost must be amortized. Also, interest must be accrued from the last interest date to the date of the open-market purchase.

Refunding Old Debt by Issuing New Debt

Refunding old debt by issuing new debt may involve two different situations: (a) Issuance of new debt in direct exchange for the old debt- In this situation, the old creditors become the new creditors. T his situation does not often occur because of settlement agreements that must be reached between the debtor and creditors involved.

(b)Issuance of new debt to obtain the cash needed to pay the creditors before maturity date- In this situation: the old paid off, and a new set of creditors lake their place.