A company that prepares its financial statements in accordance with IFRS issues ￡5,000,000 facevalue 10-year bonds on 1 January 2013 when market interest rates for such bonds are 5.50%. Thebonds carry a coupon of 6.50%, with interest paid annually on 31 December. The carrying value ofthe bonds as of 31 December 2014 will be closest to:
There are two ways to determine the value of the bonds on 31 December 2014.
First method:
Calculate the present value (PV) of the cash flows over the remaining eight years at 5.5%:￡5,000,000×6.5%×PVA(8 years,5.5%) + ￡5,000,000×PV(8 years,5.5%) =￡5,316,728. Or using a financial calculator:
PMT = ￡325,000, i =5.5%, n = 8 years, Future value =￡5,000,000. Compute PV; PV= ￡5,316,728.
Second method:
Determine the initial bond proceeds and then the amortization of the premium or discount during the first two years. The initial bond proceeds are determined using a financial calculator:
PMT = ￡325,000, i = 5.5%, n = 10 years, Future value = ￡5,000,000. Compute PV;
PV =￡5,376,881.
Using the effective annual interest rate method, which is required under IFRS, to amortize the premium gives the following:
