The student should understand that the customary procedure of opening the subscription books, making the entries with subscribers for treasury stock subscriptions, payment in cash or by instalments, and finally, the issue of the stock, may be the procedure followed in the sale of treasury stock just as in the sale of other stock. The net result will, however, be as shown by the above entry.
3. Record of Treasury Stock on the Balance Sheet. On the balance sheet treasury stock is treated in the same way as unissued stock, namely, as a deduction item in the net worth section of the balance sheet. Using the above figures for illustration, the net worth section will appear as follows:
| Net Worth | |||
| Represented by: | |||
| Capital Stock: | |||
| Authorized | $1,000,000.00 | ||
| Treasury Stock | 150,000.00 | ||
| Issued and Outstanding | $850,000.00 | ||
| Donated Surplus | 275,000.00 | ||
| Total Net Worth | $1,125,000.00 | ||
Bonds Payable.—Generally, when a corporation borrows money on long-term notes secured by a portion of its fixed assets, chiefly its holdings of real estate, the notes (usually of uniform amounts so as to make them more marketable) are called “bonds.” Thus, such notes or bonds are frequently in $100, $500, and $1,000 denominations, making it possible for one of limited means to take advantage of the mortgage offered as security for the loan. Bond issues are floated in pretty much the same way as capital stock issues, being offered for subscription at a price depending both on the interest rate which the bonds bear and the prevailing interest rate at the time of their offering. Thus, if the bonds bear 5% interest and the market rate for bonds of the same general character is 6%, an investor will naturally not be willing to pay par for them and the company will therefore have to sell them at such a discount as will put the yield to the investor approximately on a 6% basis. The company, by receiving for its bonds an amount less than par value but by being required to pay interest on the par amount, is thus paying higher than the nominal or agreed rate.
There is thus a very definite relationship between the bond discount and the interest rate which the bonds bear.
The accounting record of bond transactions is very similar to that of other liability transactions, and is shown under three heads as follows:
1. Sale of Bonds Payable. Assume that a $100,000 issue of bonds bearing 5% interest, payable semiannually, and maturing in 20 years, is sold at 90. The record will be:
| Cash | 90,000.00 | ||
| Bond Discount | 10,000.00 | ||
| Bonds Payable | 100,000.00 | ||
Bonds payable are always set up at par, since that represents the liability which must be met at maturity of the issue.
2. Bond Interest Payment. At the close of the first six months, 2½% interest, or $2,500, will be paid to the holders of the bonds. Since the corporation will have to redeem its bonds at par, it has been deprived of the use of $10,000, represented by bond discount, because the issue was brought out at 5%. The $10,000 discount is therefore in the nature of a lump sum interest cost incurred in advance—prepaid—and must be spread equitably over the life of the bonds. Accordingly, at each of the 40 interest payments during the life of the issue, a pro rata share of this prepaid interest should be taken into account as bond interest. The distribution of bond discount over the interest payments made during the life of a bond issue is termed “amortization” of the discount. Scientifically, amortization is worked out on a compound interest basis, discussion and explanation of which are found on page 269, Volume II. Here, all we are concerned with is the principle involved and for the sake of simplicity the amortization is prorated evenly over the 40 interest periods, resulting in an additional interest charge of $250 each period. The record is therefore: