 Hello and welcome to the session. This is Professor Farhad in the session. We would look at bond retirement This topic is covered in introductory accounting course as well as the CPA exam as always I would like to remind you to connect with me only then if you haven't done so YouTube is what you would need to subscribe I have 1,600 plus accounting auditing finance and tax lectures This is a list of all the courses that I cover including CPA questions If you like my lectures, please like them share them put them in playlists if they help you It means they might help other people especially these days with the corona virus out there Many people are relying on online lectures Also on my website farhadlectures.com you will find additional resources that will help you supplement your accounting education Improve your grades and pass the CPA exam. I strongly suggest you check out my website Bond retirement what does it mean bond retirement bond retirement is when the company buys back its own bond It retires the bond now one way to retire the bond is to wait until it mature at maturity What does that mean? It means you wait Until you make all your interest payment at some point the bond mature when the bond mature You will buy back the bond when the bond mature as we learned in the prior session Let me just go back and show you when the bond mature whether it's a premium bond Okay, it matures at par value and whether it's a discount bond. Let me just remind you It's always the par value So a few if we wait until the bond mature we always pay the maturity value Why because by the time it mature all the premium and all the Discount has been amortized. Therefore it will mature at par value So let's start with this simple example then carry on with our illustration. So let's talk about this bond The par value is 100,000. This was a two-year bond issued in 2019 mature in 2021 It doesn't matter whether this bond was issued at a premium or a discount by the time it mature It will be 100,000. Therefore by the time it mature we pay 100,000 We credit cash 100,000 and will debit the bonds payable. Okay Again, whether it's a premium or a discount. It will be fully amortized at maturity Therefore the carrying value equal to 100,000 at this point the bond is paid and we could move on with our life And this is a reminder that if you wait until the bond mature it reaches it reaches the par value Whether it's a premium bond notice it started at 103 But once all the premium is amortized and this is what we looked at in the prior session It goes back to 100,000 and whether it's a discount bond. It will go back again to 100,000 so the bond mature the bond mature Exactly at par value. Now we have certain bonds that are convertible or Collable so we need to understand the difference between convertible or Collable what does it mean convertible convertible means the bond holder the person that person Purchases the bond can convert into stocks. So rather than having the bond you can convert into Stocks so you can convert your bonds into stocks. That's one. That's one type of bonds So you can convert it and when you convert it what's gonna happen the bond is gone You have to remove the bond and replace it with stocks Who does this the bond holder the person that purchased the bond the person that that lend money to the company On the other hand, we have certain bonds that are callable here the corporation. So notice the difference here the corporation The corporation buys back the bond and when they buy back the bond you have no choice You have no choice. You have to give them the bond back Why because when you gave them the money the corporation told you at any point in time We have the right to call it. So the bond was callable. So notice here for callable Remember callable the corporation buys it convertible the individual doesn't have to be an individual It could be a another corporation, but to make it easy for you. It's individual that that convert Individual that convert the bond individual versus corporation. Okay Now, let's let's determine what happened when we convert a bond when a bond is converted before Maturity whether it's callable or whether it's convertible. It means it's it converted before it mature What happened before it mature if the bond is a premium or a discount bond? We have to determine the gain or the loss. So when we buy back the bond We have to determine whether we have a gain or a loss How do we determine a gain or a loss? So listen to me carefully because once you get this right, you know It's it's good to go here. Here's what happened. You have to look at the carrying value of the bond Now, what is the carrying value of the bond? Well, the carrying value, let me go back and show you what the carrying value is The carrying value of the bond we talked about this in the prior session But basically if it's a discount bond if the carrying if the bond is a discount bond, it's the bond face value minus any N amortized Discount and this is gonna give us the CV the carrying value So for example the carrying value of this bond on December 31st 2019 was 100,000 minus 36 equal to 9 so 100,000 minus 3,600 equal to 96,400 Then six months later when we amortize 900, it's 100,000 minus 2,700 equal to 97,300 and when we amortize another 900, it's 100,000 minus 1800 you get the point by the time the bond mature 100,000 minus 0 equal to 100,000. So those are the carrying value Okay, and the carrying value when it mature equal to 100,000. This is for a discounted bond for a premium bond It's the face Value plus un amortized Premium and that's gonna give us the carrying value. So when the bond starts the bond has a face value of 100,000 plus 3,600 equal to 103 600 then six months later we amortize 900. It's 100,000 plus 27 100 equal to 102 700 until We use up all the premium 100 plus 0 equal to 100 So we have to look at the carrying value when we retire the bond then compare the carrying value to how much we paid So if the carrying value is greater than the retirement price simply put if the carrying value is 98,000 and we paid and We paid only 95,000 for this bond. So the bond has a carrying value of 98 and we paid 95 we have a gain of 3,000 if The carrying value is less than the retirement price if the carrying value. Let's assume the carrying value is 106 and we're dealing with a par value 100,000 bond. So keep it simple So the par value is 100,000. So the carrying value is 106 and we paid for the bond 108 108,000 If we paid 108,000 for the bond we paid more retirement price We paid more than the carrying value. We have a loss of 2000 therefore we have to compare two numbers the carrying value to the retirement price What is the retirement price? It's the cash that we paid. How much did we pay if we pay more? We have a loss if we pay less we have a game. So let me put it for you in a different format. So you compare the cash versus the carrying value if the cash paid is more than the carrying value you have a loss if The cash that you paid for this bond is less than the carrying value You have a game. That's not Same as saying this but maybe you can easily understand it from a cash perspective So if you pay more than the carrying value you paying more than what it's worth you have a loss If you paid less you have a game. It's worth on the books, which is the carrying value So let's look at an example to illustrate this concept Assume a hundred thousand dollar bond, which is that's the par value of the bond of callable bond It means the company can buy it will retire it on July 1st after the first interest payment The bond carrying value is 104 500 now they gave you the bond carrying value They gave you the bond carrying value. So see so the bond carrying value Let's put this information here. Now, let's put it here. So the bond carrying value Because it's given sometime. It's not given sometime. You have to compute the bond carrying value equal to 104 104 500 that's the bond carrying value Now we have to determine how much did we pay for this bond? How much did we pay for this bond? Well, we paid a three thousand dollar premium premium means It's the par value plus three thousand and the cash paid and how much cash did we pay? We paid 103 Simply put we told the bond holder at any point in time we can buy the bond For 103 it means we pay three thousand premium if we pay the bond if we purchase the bond at 103 And it has a carrying value of 104 500. We paid less. We paid less than the carrying value Therefore we have a game. So how do we? Journalize this entry. Well, first we have to debit the bond. We have to debit the bond to remove the bond then we have to Debit the premium because the bond has a premium of 4500 how did I know because the carrying value is 104 500 the bond is 100,000 plus D Plus the premium. That's the carrying value. Therefore to get rid of the bond we debit the bond we debit the premium Then we paid 103 we credit we credit cash 103 and we're ready to determine a gain the gain on the bond retirement is a credit just like the gain when we did for the Plant asset is a credit 1500 so here what we did is we is We retire a bond with a callable provision. So we paid for it 103 it has a carrying value of 104 500 the difference is a game Let's take a look at another example where we convert a bond remember the conversion of bonds the stocks Who can convert the bond here? remember, let me just go back here to remind you that Who called the bond? Who called the bond who bought back the bond the corporation is kind of I wanted to kind of I Wanted to revisit this here the corporation the corporation Purchase back the bond now. We're gonna be we're gonna be looking at a conversion who convert the bond the individual It doesn't have to be an individual the reason I say individual to differentiate between the corporation and the individual So the holder of the bond will convert. Okay, why would they convert? Because they think having the stocks of the company is better than having the bond. So on January 1st $100,000 bond of Converse, which is the company with a carrying value of a hundred thousand So they're giving us the carrying value here. The carrying value is 100,000 are converted the 15,000 shares at $2 par value, okay now If we're gonna retire the bond we have to debit the bond so we have to debit the bond 100,000 and this bond is no discount and no premium So when we convert we're not gonna have this count and premium for financial accounting because it's It's beyond the scope of this course. So for the bond conversion first We have to convert the bond then we have to issue stocks So the company took out the debt and replaced the debt with stocks now. How do we How do we issue the stocks now? You don't have to worry about this because we're gonna talk about stocks in the next chapter But simply put the stocks has we're issuing 15,000 shares times $2 So we credit common stock for 30,000 and anything that remaining we credit capital Paid in capital and excess of par value for the entry to balance. Don't worry about this Again, we'll talk about this topic in the next session I just want to show you that this conversion is done by an individual. Let's take a look at another example where You will be responsible for as a student As a student. So let's take a look at this company. We have tea company issued Collable bonds. So notice callable means the company can call it with a par value of 10,000 So this bond has a par value of 10,000 the call option required the tea company to call a premium of 500 It means when they buy back the bond, they have to pay 10,500 in cash. Now, we know the cash amount that they have to pay. Yeah, that's right here on July 1st The tea company exercises the call option exercise means they went ahead and they bought the bond the call option as exercise after the semi Interest is paid The day before on June 30th record the entry to retire the bond under each separate scenario So they're telling you we make an interest payment Then we retire the bond the good news here is they're giving you the carrying value the carrying value of 9,000 So the carrying value of 9 we paid 10,500. Do we have a gain or do we have a loss under the scenario? Well, obviously we have a loss. How much is the loss the difference the difference between how much we paid and the Carrying value and what do we need to do? We need to remove the bond. We need to debit the bond 10,000 We need to credit credit the discount. So the bond The bond and the discount they go hand in hand. How did I know the discount is a thousand because look the carrying value is Is 9,000 it means we have a bond of 10,000 minus a thousand and this is how I know It's a thousand because the carrying value is 9,000. So I have to remove the bond I have to remove the discount. I paid cash 10,500. We already know this and we already computed the loss of 1,500. So then the first scenario The bond is sold is purchased back at a loss Let's take a look at the second scenario the second scenario the carrying value is 11,000 and we paid 10,500 here we have a gain of 500 why because I paid this much 10,500 for a carrying value of this much the carrying value tells me that this bond is a premium bond and I have a premium of a Thousand why because 10,000 plus a thousand of a premium will give me 11,000 of carrying value It means I have a thousand of a premium. I have to remove the bond I debit the bond debit the premium to get root of the bond and the premium Then I have to credit my cash how much I paid then I have to credit my bond Retirement which is five hundred dollars. So this is how I retire a bond. Remember, it's how much cash you paid Versus the carrying value and these are two separate independent scenarios If you like this recording, please click on the like button share them put them in playlist in the next session I would look at long-term notes payable and please take a look at my website for health lectures calm if you're looking to supplement your accounting education and or Spass your CPA exam study hard and stay safe during those corona virus days