The CEO of Redstone Ltd has just been discussing a planned new debenture issue with the financial
Question:
The CEO of Redstone Ltd has just been discussing a planned new debenture issue with the financial advisers, and has come to you with some resulting accounting questions. Answer each of the following:
1. 'We are thinking of setting the interest rate on the debentures a little above current market rates, to make them more attractive. I'm told this will produce a balance sheet liability higher than the face value of the debentures. How does this happen?'
2. 'Your answer to my first question is troubling. How can it make sense to show a liability higher than the amount we will have to pay when the debentures are due? What will we do with the difference then?'
Step by Step Answer:
1 When you set the interest rate on the debentures a little above current market rates the debentures become more attractive to investors because they offer a higher return Therefore they may be willing to pay a premium more than the face value to purchase these debentures When a company issues bonds at a premium it means the company is able to receive more cash than the face value of the bond On the balance sheet the debentures will initially appear at the amount of cash received that is premium face value which is more than the face value The difference between the actual cash received and the face value is known as bond premium So in essence the liability isnt increasing but the premium amount is being added to the liability 2 When the debentures mature the company is obligated to pay the debenture ...View the full answer
Financial Accounting An Integrated Approach
ISBN: 9780170349680
6th Edition
Authors: Ken Trotman, Michael Gibbins, Elizabeth Carson
