Odomirok spends a couple of pages talking about the four sources of investment income from bonds.
#1) Interest received during the year.
#2) Interest due and accrued.
#3) Current year's amortization/accretion.
#4) Interest paid for accrued interest on dividends.
#1 and #3 are pretty easy to understand.
I think I understand #2, but "accrual basis" isn't really explained, and a numerical example could really help. Here's what I think it is (please feel free to clarify).
ABC buys a $100K (4% interest) bond on 7/1/2012. On 12/31/2012, ABC still holds the bond, but has not received any interest payments. But ABC has "earned" half of the bond payments -- that is 2%. So:
Item #1 = $0K.
Item #2 = $2K.
Earned over period = $2K (sum of #1 and #2)
ABC receives a payment on 7/1/2013 of $4K. Also, during the year, ABC "earned" $2K from the first coupon payment during the first half of the year and $2K from second coupon payment (not yet received) during the second half of the year. On 12/31/2013, ABC has again "earned" $2K that it hasn't yet received, which is the same as it was the previous year ... thus no change.
Item #1 = $4K.
Item #2 = $0K.
Earned over period = $4K.
Finally, the bond matures on 7/1/2014. On 12/31/2014, the "earned" portion not yet received = $0K, which is a drop of $2K.
Item #1 = $4K.
Item #2 = -$2K.
Earned over period = $2K.
Does that sound right?
Then comes Item #4. I'm confused because Odomirok says, "the buyer is required to pay the seller of the bond the portion of the coupon payment that was earned while they owned the bond." But if coupon payments come at the end of the period, shouldn't it really say " ... that will be earned..."?
Let's say ABC sells the bond to DEF on 10/1/2013.
From 7/1/2012 to 10/1/2013, ABC has "earned" a grand total of $5K ($1K per quarter), but has only received $4K in coupon payments. So, it seems to me that DEF owes ABC $1K.
... and wait ... I think I just now figured it out. "... earned while they owned the bond" is referring to the buyer. Not the seller.
Stupid English. Anyway, let me finish out the example:
ABC's Income 12/31/2012:
Item #1 = $0K
Item #2 = $2K
Item #4 = $0K
Earned during year = $2K (the sum)
ABC's Income 12/31/2013:
Item #1 = $4K
Item #2 = -$2K
Item #4 = $1K
Earned during year = $3K (the sum)
How's that sound?
#1) Interest received during the year.
#2) Interest due and accrued.
#3) Current year's amortization/accretion.
#4) Interest paid for accrued interest on dividends.
#1 and #3 are pretty easy to understand.
I think I understand #2, but "accrual basis" isn't really explained, and a numerical example could really help. Here's what I think it is (please feel free to clarify).
ABC buys a $100K (4% interest) bond on 7/1/2012. On 12/31/2012, ABC still holds the bond, but has not received any interest payments. But ABC has "earned" half of the bond payments -- that is 2%. So:
Item #1 = $0K.
Item #2 = $2K.
Earned over period = $2K (sum of #1 and #2)
ABC receives a payment on 7/1/2013 of $4K. Also, during the year, ABC "earned" $2K from the first coupon payment during the first half of the year and $2K from second coupon payment (not yet received) during the second half of the year. On 12/31/2013, ABC has again "earned" $2K that it hasn't yet received, which is the same as it was the previous year ... thus no change.
Item #1 = $4K.
Item #2 = $0K.
Earned over period = $4K.
Finally, the bond matures on 7/1/2014. On 12/31/2014, the "earned" portion not yet received = $0K, which is a drop of $2K.
Item #1 = $4K.
Item #2 = -$2K.
Earned over period = $2K.
Does that sound right?
Then comes Item #4. I'm confused because Odomirok says, "the buyer is required to pay the seller of the bond the portion of the coupon payment that was earned while they owned the bond." But if coupon payments come at the end of the period, shouldn't it really say " ... that will be earned..."?
Let's say ABC sells the bond to DEF on 10/1/2013.
From 7/1/2012 to 10/1/2013, ABC has "earned" a grand total of $5K ($1K per quarter), but has only received $4K in coupon payments. So, it seems to me that DEF owes ABC $1K.
... and wait ... I think I just now figured it out. "... earned while they owned the bond" is referring to the buyer. Not the seller.
Stupid English. Anyway, let me finish out the example:
ABC's Income 12/31/2012:
Item #1 = $0K
Item #2 = $2K
Item #4 = $0K
Earned during year = $2K (the sum)
ABC's Income 12/31/2013:
Item #1 = $4K
Item #2 = -$2K
Item #4 = $1K
Earned during year = $3K (the sum)
How's that sound?
Odomirok Chapter 8
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