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Dear Mike,
I went through an exercise last night that was confusing. The transaction cost of a financial liability (bond) was deducted from the fair value of the consideration received (face value of the bond) — so if the face value of the bond was 6 millions and the transaction cost 120k
the fair value of the liability on the financial statement at recognition was 5.82 millions. So fa so good. However, what confuses me its when in the exercise the apply the coupon rate on the 5.82 millions to calculate the yearly charge to SPL. The coupon rate is a fixed interest that should be applied on the full face value of the bond.Could you kindly clarify for me?
Gratitude,
StefanoHi,
You need to be careful in looking at the coupon rate and the effective rate of interest on the bond.
The coupon rate is applied to the par value of the bond, as this is what must legally be paid as part of the contract.
The effective interest is applied to the outstanding liability, so here the 5.82 million, as this is accounting for the cost of the borrowing over the life of the instrument where we are growing the value of the liability up to its redemption amount.
Thanks
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