On December 31, 20X3 Okay Company issued 10,000 $1000 face value 10-year, 9% bonds to yield 7%. The bonds pay interest semi-annually. On its financial statements (prepared under U.S. GAAP) for the year ended December 31, 20X4, the effect of this bond on Okay’s cash flow from operations is:
A. -$900,000.
B. -$700,000.
C. -$755,735.
I cannot understand what is meant by 9% bonds to Yield 7%. Do we have to treat as Effective Annual Interest rate/Market Rate?
The solution is 900000. However, the problem is that with A as solution, the bond has been treated as issued at Par. However, I think that the difference between coupon rate and yield imply that bond has been sold at premium.
The bonds were issued at a premium.
I am greatful to you for your reply. ’
The real issue was that I was missing that the questions asks us to follow GAAP, and according to GAAP we need to classify all expenses as operating expenses in Cash Flow rather than reporting principal portion of the coupon amount as financing cash flow
The cash flow statement doesn’t have expenses; it has cash flows.
Suppose that you issue 10 million in 5% coupon bonds. Your annual coupon payments will be 500,000, which is the number that goes on the cash flow statement. Your Interest Expense may be:
- Higher than 500,000 (if they were issued at a discount)
- Equal to 500,000 (if they were issued at par)
- Lower than 500,000 (if they were issued at a premium)
Thank You for the Great Response. With a just single response, you taught me many things. I highly appreciate.