One concept I want to clarify is when we caculate interest for bond, accounting wise, we always just use coupon rate multiply principle, right? ( this affects interest paid, CFO…) the interest rate multiply principle and amortization concept is just for financial analysis? but not for accounting purpose? Am I correct?

I think you use the actual issue price (par *premium / disount) as your base value and then use the coupon from there Can someone confirm this?

I’m not sure exactly what you’re going for, but as far as the accounting goes, this may help clarify something… $100,000 bond issued by a company issued at a premium of $105,000 Semi-annual payments 10% coupon rate 8% market rate 6 months after issuance, * the holder would receive $5,000 (coupon x face) * the holder would recognize $4,200 (market rate x issuance premium) in interest * the $800 difference would reduce the book value of the debt to $104,200 At maturity, the total of BV reductions would bring the BV of debt to face value. Getting back to your question, the cash flow effects arise from the coupon x face. The premium and liability reduction math is purely an accounting treatment.

Shouldn’t the premium and liability reduction math be part of financial analysis treatment instead of accounting treatment? What I mean is, in the financial statement, the interest rate recorded will always be the PV of the bond * Coupon rate, there is no amortization as you just showed. Amortization is adjustment made by the analyst. the question was raised from the following example: Given the following information on the annual operating results for ArtFrames, a producer of quality metal picture frames, calculate the degree of operating leverage and the degree of financial leverage. Sales of 3.5m Variable costs at 45% of sales Fixed costs of $1.05 million Debt interest payments on $750K issued with an annual 9% coupon, current yield is 7%, What is the DFL? A1.06 B1.08

My guess is A . I think we should use 7% to calculate the interest expense since DFL = EBIT/EBIT- Interest ( All from the income sheet )

In this problem - because it is given as Current Yield – that is what should be used. So 1.06 is the answer with .0525 Mill as the Interest expense.

Would we have used 7% in case it was YTM instead of current yield?

Yes, even then. Then however the Interest expense would not have been based on the 750K but on the actual bond liability, I think.

Hm.

zeroaffinity in the above calc DFL = [Q(P-V) - F] / [Q(P-V) - F - Int] I believe 1. you flipped .8075 and .875 (numerator and denominator) 2. Interest expense is not Coupon * Face it is bond liability * YTM. isnt it? CP

Argh. I just deleted that by accident. Yeah. Flipped by mistake … I realized that my answer was not either of the choices! Flipping would give 1.08 as the answer. Anyway, I don’t know why the yield should be used. What’s the rationale for that?

SO the conclusion is that since we need to calculate DFL, we need to pick the interest expense from the NI statement and not the actual cash flow. I hope!!!

the answer is 1.08, it uses coupon rate. that is why it confused me. refer to schweser book 3 bond section, when it comes to accounting, we should always use coupon as interest calculation. and that is why some time CFO is understated/overstated, difference with YMT. amortization is just financial analysis? true?

I thought it was coupon * face. My hangup is that applying the yield to the face says nothing about either cash flows or obligations of the company. The coupon rate, however, says something about both. The yield should only be of interest to the debt holder I would think. So using my now-vanished explanation, I thought the answer would be 1.08 using the coupon rate. What’s the answer, singlesong?

> […] when it comes to accounting, we should always use coupon as interest calculation. > and that is why some time CFO is understated/overstated, difference with YMT. > amortization is just financial analysis? true? Not to split hairs, but it’s all for financial analysis. If you’re talking about CF, then recognize that bond premiums and discount amortizations are just that: amortizations. They fall into the basket of non-cash items like depreciation. Interest expense, however, will obviously impact CF, but when adding depreciation back to NI for CFO, I would do the same with amortization. Note: I just googled for a 10-q example and found this. You can see in the stmt of cash flows where they add back amortization of bond prem/disc - search for the first instance of the word amortization. http://sec.edgar-online.com/1997/05/15/00/0000950130-97-002413/Section13.asp HTH

Yes for CF it makes sense. What do we need to consider for the interest expense while calculating DLF?