| LO1 – Describe the nature of bonds and the rights of bondholders. |
A bond is a debt instrument generally issued to many investors that requires future repayment of the original amount at a fixed date, as well as periodic interest payments during the intervening period. A contract called a bond indenture is prepared between the corporation and the future bondholders. It specifies the terms with which the corporation will comply, such as how much interest will be paid and when. Another of these terms may be a restriction on further borrowing by the corporation in the future. A trustee is appointed to be an intermediary between the corporation and the bondholder. The trustee administers the terms of the indenture.
Ownership of a bond certificate carries with it certain rights. These rights are printed on the actual certificate and vary among bond issues. Individual bondholders always acquire two rights.
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The right to receive the face value of the bond at a specified date in the future, called the maturity date, and The right to receive periodic interest payments, usually semi-annually, at a specified percent of the bond’s face value. |
Every corporation is legally required to follow a well-defined sequence in authorizing a bond issue. The bond issue is presented to the board of directors by management and must be approved by shareholders. Legal requirements must be followed and disclosure is required in the financial statements of the corporation.
Shareholder approval is an important step because bondholders are creditors with a prior claim on the assets of the corporation if liquidation occurs. Further, dividend distributions may be restricted during the life of the bonds. Affected shareholders usually need to approve this. These restrictions are reported to the reader of financial statements through note disclosure.
There are as well several additional considerations related to the decision to issue bonds.
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