Non-current liabilities calculation


Can anyone explain me how the numbers in exercise 4 and 5 page 580 FRA Curriculum are calculated ?

I checked the anserw but don’t know the formula

For Q4)

-You first need to calculate the proceeds of the bond, in the question they tell you the annual interest payments are 55 000 implying a coupon a coupon rate of 5.5%. So you know the bonds will sell for discount because the market rate is 6%. So intuitively the sale proceeds must be less than $1 000 000.

-You have a 5 year bond, making 5 annual interest payments of $55 000, with a face value of 1 000 000 and market interest rate of 6%. Plug in those numbers into your calculator and you will get a PV of 978 938.1811

-As a bond approaches maturity we amortise the discount/premium so that it approaches it’s face value. Since this bond was issued at a discount at the beginning of the year we know that at the end of the year it should be greater than $ 978 938. 1811.

-To calculate the amortised amount, you need to calculate the difference between the effective interest paid and the actual interest payments.

-the effective interest paid is (978 938.1811 * 0.06) =$58 736.29

-58 736.29 – 55 000 (annual interest payments – this what they actually pay every year) = $ 3 736 .29

-978 938.1811 + 3736 = 982 674. 472

  • Therefore they recognize a liability of 982 674.

-Note the company will pay cash of $55 000 related to the interest payment, but interest expense on the income statement will also reflect the $3 736 related to amortisation. i.e., int exp recorded on the income statement will be 58 736. Also amortisation is a non cash item therefore the CASH flow at the end of the year is only 55 000. That’s why A and C are incorrect. giving B as the answer

Q5 is essentially the same but the bond is issued at a premium because the coupon rate is greater than the market rate. If you can’t work it out go over pages 536 - 541. If I just spit out the answer you won’t learn anything