Bond issued at Premium 102,531. Market interest rate: 9% Annual Coupon: 10% Face Value: $100,000 3 year bond Interest Expense: 102,531 * .09 = $9,228 Coupon Payment (actual cash paid) = $10,000 Book States: For premium bonds CFF is overstated (this makes sense since face is $102,531) But it also says CFO is understated. How is CFO understated if the company is paying out $10,000 vs a $9,228 interest expense? Are they assuming it is understated relative to the interest that should be paid if the coupon was multiplied by the face value + premium?
Let’s say bond is issued at par $100,000, then your interest expense should be $9,000 instead of $9,228. So CFO is understated as a result of issuing a premium bond( you’re paying more interst expense) Or simply as CFF is overstated, either CFO or CFI needs to be understated in order to balance. As we know paying interest expense or paying dividend is operating activities, we know CFO is understated. Hope it makes sense and correct me please if I am wrong.
dhyun3 Wrote: ------------------------------------------------------- > Or simply as CFF is overstated, either > CFO or CFI needs to be understated in order to > balance. +1 This way it is easier to be spot on in an exam question, without wasting much valuable time on that question.
I see what your saying but Interest Expense is not the same as CFO when a bond is issued at a premium or a discount. CFO is the coupon payment itself. Bond issued at Premium 102,531. Interest Expense: 102,531 * .09 = $9,228
You are right that interest expense is lower than coupon payment but this is why CFO is understated. You paid out more, resulting in lower CF from operation.
another small correction on something that dhyun3 had made above - dividend payments are CFF - NOT CFO. I think you are getting confused between Dividends received and Dividends Paid. and also the subtle difference between treatment of dividend received between IFRS and GAAP.
hi all, I think I was confused between dividends paid and received. Thanks everyone for correcting my mistakes.
revenant Wrote: ------------------------------------------------------- > You are right that interest expense is lower than > coupon payment but this is why CFO is understated. > You paid out more, resulting in lower CF from > operation. revenant is right on the point.
is opposite true for discount bond? CFF understated and CFO overstated?