Recording A New Bond Issue
Situation
Teachum State University just issued a tax-exempt $10 million term bond to finance the construction of a new nursing academic building. The bond proceeds received from the bond underwriter were net of certain items that included an original issue discount cost, an underwriter’s discount fee, bond insurance premium and accrued interest. Chief Business Officer Wayne Cate has never prepared the general journal entry to record a bond issue and would like a sample journal entry that illustrates the documentation.
Response
Prior to the GASB 35 reporting model, Teachum State University would have recorded transactions pertaining to the new bond issue in three separate funds within the plant fund. However, to more efficiently prepare financial statements according to the GASB 35 reporting model, Teachum State University has consolidated its plant funds into one fund group for budgetary and operating purposes. The following general journal entries illustrate how Chief Business Office Cate would record the new bond issue in the combined "Plant Fund" accounts.
The illustration assume the following facts. The university issued $10 million of 8% term bonds on October 1, 2002, due on July 1, 2012 with interest payable each July 1 and January 1. The bond was sold to yield 10 %.
|
Bond |
$10,000,000 |
|
Bond discount |
772,200 |
|
Underwriters discount |
200,000 |
|
Bond insurance premium |
25,000 |
The following are sample journal entries to record the new bond and subsequent construction costs of the new nursing building.
In the Plant Activities
|
Cash |
$ 9,202,800 |
|
|
Bond discount |
772,200 |
|
|
Underwriters discount |
200,000 |
|
|
Bond insurance expense |
25,000 |
|
|
Bond payable |
|
10,000,000 |
|
Bond interest expense |
|
200,000 |
To record the October 1, 2002 issuance of $10,000,000 ten-year term bonds dated July 1 with 8% interest payable semiannually.
While the bond issue costs could be amortized using the effective interest method, the straight-line method is generally used in practice according to APB Opinion No. 21 because it is easier and the results are not materially different. The bond discount should be amortized using the effective interest method unless the straight-line method is not materially different. To determine which method is used, Chief Business Officer Cate must calculate the bond discount amortization using both methods to determine whether any material s. The bond discount amortization method is determined based upon the calculation. This illustration assumes that the effective interest method is used to amortize the bond discount and the straight-line method is used to amortize the bond issuance costs.
Six months after the date of the bond, the first interest payment would be due. On January 1, 2003 the following transaction will be recorded.
|
Bond interest expense |
$461,400 |
|
|
Bond issue expense |
$10,000 |
|
|
Bond discount |
$61,400 |
|
|
Underwriters discount |
|
$10,000 |
|
Cash |
|
$400,000 |
To record the semiannual bond interest obligation
At the end of the fiscal year [June 30], the journal entry would record the interest expense payable at July 1 together with the amortization of the discount.
As the construction of the nursing building takes place, the cost would be accumulated in a construction in progress account. For example:
|
Construction in Progress |
$1,500,000 |
|
|
Cash |
|
$1,500,000 |
Since Teachum Sate University serves as the general contractor on the nursing building construction project, the university has a choice of recognizing the construction activities using either the completed contract or percent-of completion method using AICPA Statement of Position No. 81-1 guidance. Because Teachum State University wants to combine the construction costs into entry, the University has adopted a policy that all construction projects will be accounted for using the completed contract method. Therefore all construction costs for the new nursing building and recorded in and reported as an assist – construction in progress. When the nursing building is completed, the construction in progress account is closed and the capital assets recognized in the appropriate category, depreciation expense is then recognized.
For example let's assume that the building was completed and an occupancy certificate was received on April 1 of a future fiscal year. On that date, the following entry would close the construction in progress account.
|
Building |
$8,500,000 |
|
|
Equipment |
$1,500,000 |
|
|
Construction in Progress |
|
$10,000,000 |
At the end of the fiscal year, three months of depreciation expense would be recognized for the nursing building [assume to have a 50-year life with no residual value] and for the equipment [assumed to have a 10-year life wiht no residual value].
|
Depreciation expense |
$80,000 |
|
|
Accumulated depreciation on building ((.02 x8500000) x .25) |
|
$42,500 |
|
Accumulated depreciation on equipment (( .1 x 1500000) x .25) |
|
$37,500 |
|
To recognize the depreciation expense for the nursing building and equipment |
|
|
Note: This illustration does not reflect the capitalization of interest incurred during the period of construction. Nor does it reflect any investment activities of the bond proceeds during the building construction. Under normal circumstances, the capitalized cost of buildings includes the net interest incurred during the construction period. Also, good management practice would dictate that the idle case be invested in a secure investment such as a government security. Governing board policy would determine whether the interest earned on the investment would be available for nursing building construction or general institutional use. Irrespective of the use of the interest earnings, GAAP requires that interest earnings offset the capitalized interest.