Interest

Examples of Interest in the following topics:

• Times Interest Earned Ratio

  • Times Interest Earned Ratio = (EBIT or EBITDA) / (Required Interest Payments), and is indicative of a company's financial strength.
  • The Times Interest Earned Ratio indicates the ability of a company to meet its required interest payments , and is calculated as:
  • Times Interest Earned Ratio = Earnings before Interest and Taxes (EBIT) / Interest Expense.
  • The Times Interest Earned Ratio is used by financial analysts to assess a company's ability to pay its required interest payments.
  • If Company A's EBIT is 750,000 and its required interest payments are 150,000, itsTimes Interest Earned Ratio would be 5.

• Cost of Interest During Construction

  • The amount of cash borrowed will incur interest expense to the borrower; the interest paid by the borrower serves as interest income to the lender.
  • The capitalization of interest costs involves adding the amount of interest expense incurred and/or paid during the asset's construction phase to the asset's cost recorded on the balance sheet.
  • This interest cost is recorded as interest expense and reported as a period cost on the income statement rather than the balance sheet.
  • Most of the interest paid during construction is part of an asset's cost.
  • Interest paid during delays in construction is excluded from the asset's cost.

• Bonds Payable and Interest Expense

  • Example of bonds issued at face value on an interest date:-
  • Valley made the required interest and principal payments when due.
  • To record periodic interest payment.
  • Valley must make an adjusting entry on December 31 to accrue interest for November and December.
  • Summarize how a company would record the original issue of the bond and the subsequent interest payments

• Bonds Issued at Par Value

  • The affected accounts will be interest expense and cash, and the journal entry will be as follows: Interest Expense $70 Cash $70At bond expiration, the creditor must make a journal entry for the last interest payment and the retirement of the bond through principal payment.
  • Next, it generally pays interest during the term of the bond.
  • When the company makes an interest payment, it must credit, or decrease, its cash balance by the amount it paid in interest.
  • Bond Interest Expense - debit interest payment (increase interest expense line)
  • First, it must record any final interest payments that are made.

• Reversing Entries

  • Some examples of reversing entries are salary or wages payable and interest payable.
  • If the loan is issued on the sixteenth of month A with interest payable on the fifteenth of the next month (month B), each month should reflect only a portion of the interest expense.
  • This adjusting entry records months A's portion of the interest expense with a journal entry that debits interest expense and credits interest payable.
  • The entry credits interest expense and debits interest payable.
  • When the full amount of the interest is paid in month B, each month's books will show the proper allocation of the interest expense.

• Bonds Issued at a Premium

  • The company must pay $6,000 in interest annually, so the company's annual interest expense equals $5,000.
  • When the business pays interest, it must also amortize the bond premium at that time.
  • Every time interest is paid, the company must credit cash for the interest amount paid to the bond holder.
  • The difference between the amount paid in interest and the premium's amortization for the period is the interest expense for that period.
  • The company must pay $6,000 in interest annually, so the company's annual interest expense equals $5,000.

• Issuing Bonds

  • The more risk assessed to a company the higher the interest rate the issuer must pay to buyers.
  • If a bond has a coupon interest rate that is higher than the market interest rate it is considered a premium.
  • Bonds are considered issued at a discount when the coupon interest rate is below the market interest rate.That means a company selling bonds at a discount rate receive less than the face value of the bond in the sale.
  • Other journal entries associated with bonds is the accounting for interest each period that interest is payable.
  • The journal entry to record that is a debit interest expense and a credit to cash.

• Components of a Note

  • A notes receivable normally requires the debtor to pay interest and extends for time periods of 30 days or longer.
  • Interest-notes generally specify an interest rate, which is used to determine how much interest the maker of the note must pay in addition to the principal.
  • Calculating interest-interest on short-term notes is calculated according to the following formula:
  • principle x annual interest rate x time period in years = interest

• Factors Affecting the Price of a Bond

  • A bond's coupon is the interest rate that the business must pay on the bond's face value.
  • These interest payments are generally paid periodically during the bond's term, although some bonds pay all the interest it owes at the end of the period.
  • As a result, the interest that is paid to the bond holder fluctuates over time with an indexed coupon rate.
  • A bond's value is measured based on the present value of the future interest payments the bond holder will receive.
  • In practical terms, the discount rate generally equals the coupon rate or interest rate associated with similar investment securities.

• Valuing Zero-Coupon Bonds

  • If the effective interest rate is 7%, what are the proceeds?
  • How much interest expense is recognized?
  • The effective interest rate method indicates that interest expense must be recognized each period the bond is outstanding, even if no cash interest is being paid.
  • While the business may not make periodic interest payments, interest income is still generated.
  • Zero-Coupon Bond Value = Face Value of Bond / (1+ interest Rate)