contract rate

(noun)

Another term for coupon rate, this is the amount of interest the business will pay on the principal of the bond.

Related Terms

Examples of contract rate in the following topics:

  • Bond Valuation Method

    • Whether the amount the business will receive equals its face value depends on the difference between the bond's contract rate and the market rate of interest at the time the bond is issued .
    • The bond's contract rate is another term for the bond's coupon rate.
    • Regardless of what the contract and market rates are, the business must always report a bond payable liability equal to the face value of the bonds issued.
    • If the market rate is less than the coupon rate, the bonds will probably be sold for an amount greater than the bonds' value.
    • The discount rate for both the principal and interest payment components is the market rate when the bond was issued.

  • Valuing Zero-Coupon Bonds

    • The value of a zero-coupon bond equals the present value of its face value discounted by the bond's contract rate.
    • If the effective interest rate is 7%, what are the proceeds?
    • Zero-Coupon Bond Value = Face Value of Bond / (1+ interest Rate)
    • The present value is determined using the interest rate stated on the bond.
    • If the interest rate of the bond is expressed as a monthly rate and the term of the bond is 10 years, the bond term should be expressed as 120 months when making the calculation.

  • Bonds Issued at Par Value

    • Consider a 3-year bond with a face value of $1,000 and an effective interest rate of 7%, sold at face value.
    • This generally means that the bond's market and contract rates are equal to each other, meaning that there is no bond premium or discount.

  • Bonds Issued at a Premium

    • Assume a business issues a 10-year bond that has an effective annual interest rate of 6%, with a face value of $100,000.
    • This would make the amortization rate of the bond's premium equal to $1,000 per year.
    • This generally means that the bond's contract rate is greater than the market rate.
    • The company must debit the bond premium account by the amortization rate.
    • This would make the amortization rate of the bond's premium equal to $1,000 per year.

  • Bonds Issued at a Discount

    • Assume a business sells a 10 year, $100,000 bond with an effective annual interest rate of 6% for $90,000.
    • When a bond is sold at a discount, the market rate of the bond exceeds the contract rate.
    • Generally, the amortization rate is calculated by dividing the discount by the number of periods the company has to pay interest.
    • That means that the amortization rate on the bond payable equal $1,000 ($100,000/10 years).
    • While the business would only have to pay the bondholder $6,000 in cash, its total interest expense equals $7,000, or the amount of interest it pays plus the amortization rate.

  • Franchises and Licenses

    • How a franchise is recorded on a balance sheet depends on the conditions of the contract.
    • For a franchise, the useful life is generally the length of the franchise contract.
    • The amortization rate is calculated by dividing the initial value of the asset by its useful life.
    • Every accounting period, the value of the asset is decreased by the amortization rate.
    • The business also records an expense equal to the amortization rate every accounting period.

  • Other Current Liabilities: Sales Tax, Income Tax, Payroll, and Customer Advances

    • The tax amount is usually calculated by applying a percentage rate to the taxable price of a sale.
    • Expenses can vary; for example, corporate expenses related to fixed assets are usually deducted in full over their useful lives by using percentage rates based on the class of asset to which they belong.
    • An example of a typical customer advance is the receipt of an annual maintenance contract fee, where the entire contract is paid up front.
    • The receipt of $12,000 for the annual maintenance contract is initially recorded as deferred revenue.

  • Notes Payable

    • The terms of a note usually include the principal amount, interest rate (if applicable), parties involved, date, terms of repayment (which may include interest), and maturity date.
    • It's important not to confuse a note with a loan contract, which is a legally distinct document from a note.

  • Factors Affecting the Price of a Bond

    • A bond's book value is affected by its term, face value, coupon rate, and discount rate.
    • While the coupon rate is generally a fixed amount, it can also be "indexed. " This means that the interest rate is calculated by taking an established rate that fluctuates over time, such as a bank's lending rate, and adding a "premium" percentage amount to determine the bond's coupon rate.
    • To calculate the present value, each payment is adjusted using the discount rate.
    • In practical terms, the discount rate generally equals the coupon rate or interest rate associated with similar investment securities.
    • Explain how a bond's value is affected by its term, face value, coupon and discount rate

  • Recognition of Revenue Prior to Delivery

    • Percentage-of-completion method: if a long-term contract clearly specifies the price and payment options with transfer of ownership -- the buyer is expected to pay the whole amount and the seller is expected to complete the project -- then revenues, expenses, and gross profit can be recognized each period based upon the progress of construction (that is, percentage of completion).
    • For example, if during the year, 25% of the building was completed, the builder can recognize 25% of the expected total profit on the contract.
    • Percentage of completion is preferred over the completed contract method.