 Hello, in this lecture we're going to talk about the issuance of a bond at a discount. We will calculate and record interest payments on the bond. We will be able to record the journal entry for the issuance of a bond at a discount, explain the effect of recording the journal entry on the trial balance accounts, calculate the interest payment and amortize the bond discount using a straight line method, record the journal entries related to interest payments and amortization of bond discount, explain the effect of recording the journal entry on the trial balance accounts. All right, so we're going to look at this in context of a problem. We're going to have the information on the left-hand side. We're going to look at a trial balance and post this within context of a trial balance. We can see it in relation to other numbers and see the balancing concepts within the trial balance. In the trial balance, we're going to have a simplified trial balance where we have just a couple assets, those assets being cash and accounts receivable. We've got the liabilities account payable. Then where we are focusing in this area will be the bonds payable, the discount on the bonds, and then we've got the common dividend payable as the another liability. Then we have the equity section and one thing in there at this time, retained earnings. Then we have the income statement being sales, income and expenses. We just have income over the 700 at this time. That is income, not a loss. The brackets representing credits and that will give us a net income number which we can use to see what will happen to net income as we post some journal entries related to bonds and bond interest payments as we go. Also note that debits are going to be represented without brackets and there are going to be positive numbers and credits will have brackets or negative numbers. This will be a simplified way for us to see the debits and credits. If we were to add up the debits minus the credits, it would add up to zero, therefore the debits equal the credits. It'll give us a nice simplified way for us to calculate everything we need to see within one page and limit the amount of columns we are going to need to use. First thing we want to do is just discuss what a bond is, how it is compared to a note and look at our information on this side. We issued a bond which pay interest semi-annually. It's a 15-year bond. It's a semi-annual bond. It's going to have a face value of 240 and it's got an interest rate of 6%. These are things that are going to be on the bond so if we were to actually have a physical bond which we don't usually have these days because it's all electronic, but they would be part of the terms of the bond. If we were working a problem, these are the things that you want to think are like set in stone in the bond. We cannot change these things. They are part of the bond. That means that we are the issuer of the bond. When we think of bonds as an individual, we often probably think of it as if we were thinking about investing into a bond. It's good to think on both sides of the table. It's often difficult when we think about problems to think on both sides of the table. In this case, we are the issuer of the bond and we then are going to pay the bond back to whoever is holding the bond at the end of the period, which in this case is 15 years. We will pay them the face amount of 240,000 and we will be paying interest on the bond to whoever is holding the bond semi-annually, so twice a year and we'll be paying 6% of the 240,000. We will then calculate that out. Notice the difference between a bond and a note payable. A note payable is very similar to a bond where we would borrow money and we would pay it back in the future in some format and most people have experience with a note payable in terms of a car payment or a mortgage payment and in those types of payments, what happens is we borrow money and then we're going to pay it back and we pay back both the principal and interest usually in monthly arrangements. In this case, we are only going to be paying the interest on the note, so that's going to be the difference. Oftentimes with bonds, bonds could be set up in many different ways, but this is going to be a common type of bond, common type of bond problem in which we are just going to pay the interest. That means that as we make the semi-annual interest payments, we are only paying, I call it like the rent on the money. So if we were to rent an apartment, we pay back just the rent, the use of the apartment. Such as a mortgage where we pay back part of the principal. We don't give back part of the apartment each time we pay the rent. We only pay back the use of the apartment. Similar to if we have borrowing money, in this case we're borrowing money. We are paying back the rent basically on the borrowed money. We're not paying back any of the principal, the stuff we're using. We're just paying back the interest until the end of the term in which case at which time we will pay back the principal of the 240. Also note the two things that change when we talk about loaning money. If you go to the bank and you say, I need a loan, you can say, well, I need this much money and they're going to then negotiate on terms of what the rent should be. What should the interest on the loan be? How much should you pay me in order for you to have the use of the resource being the money and you can adjust the interest payments? The problem on a bond you want to realize is that the interest payment is set in stone. Remember, that's one of those things that you want to think that the bond is already written. When we issue the bond, you want to think, well, the bond's already written and the bond already has a face amount. It already has an interest amount. If we are going to go on a market and negotiate over a bond, we can't adjust the interest amount as we would for a note. We need to adjust something else. That something else is going to be the same thing we would adjust for anything else we sell and that's going to be the sales price. So if we were to sell something a tangible good, then of course we would haggle over what the sales price should be. If we are selling a bond, it's kind of the same thing. We're going to say, well, this is set in stone, the interest rate set in stone, the face amount is set in stone, but we can haggle over the price that we will sell this for. In terms of this note, we're going to say, yeah, we're going to pay back whoever owns the note, 240,000. We're going to pay interest at a rate of 6% semi-annually. And how much would you like to buy this bond for? And if we put that on the market, then a problem is always going to have to give you kind of the market rate and the interest rate on the bond. So the market rate is kind of, it's not set in stone. That's the negotiable wet rate. So when you go on to the free market and you try to sell something, well, if it turns out that people can buy similar bonds at a rate of 8%, meaning they can take their money, give it to someone else, and earn rent on it for a higher amount, just like if I was to take my apartment and sell it to somebody else and they're going to pay me more rent than this person is, then I'm going to sell it to the person who pays the most rent. Therefore, if the market rate is higher, then the interest rate on our bond, and we're trying to sell our bond, then we're going to have to sell it for less than the face amount of the bond. So we'll say, OK, you don't have to give us 240,000 for it. We'll give it to you at a discount. So that's the idea we're going to say. We're going to give it to you at a discount. When you think of a discount versus a premium, it's easier to think of it in terms of if we are the person purchasing the bond, because I think we have more experience with that. If you go to the store and it says the sticker price said something like the face amount, in this case, is the sticker price, and it said 240,000, and we paid for something less than 240, we would say that we got a discount on it. If, on the other hand, we paid more than the sticker price, we would pay a premium on it. Why would we ever pay more than the sticker price on the bond? Well, that would be, of course, the opposite here. If the market rate happened to be less than the rates on the bond, then we would have to, we would be selling it. The issue would be selling it at a premium. The purchaser would be buying it at a premium. And of course, either of those situations could happen because the interest rate on the market fluctuates due to a lot of different factors. So if we go through here and we think about the journal entry as we issue the bond, so if we're going to issue the bond here, then how are we going to record this? Remember, the reason why a company would issue a bond is because they're trying to get money. So we're trying to get money in order to fund whatever we're trying to fund for the business. And so is cash affected? We're going to say, yeah, cash is affected in this case. And cash is going to go up. Cash has a debit balance. We're going to make it go up by doing the same thing to it, which in this case would be another debit. Now, the next thing that's going to happen will, of course, be that, why did we get cash? Because we promised to pay at the end of the 15-year period, 240,000 plus rent on that money that we borrowed at 6%. So that means that we have signed an obligation to owe back the money in the future. That money that we owe back will be at the end of 15 years, 240,000. So the bond payable is a liability. All liabilities have credit balances. We need to make it go up by the amount that we're going to pay back at the end of the time period, which is 240. So we're going to credit the 240 increase in the liability that we owe. Also want to point out here that you could get this amount confused one with the issue price, how much money we're going to receive. And the reason we're going to say the bond payables for 240 is because that's how much we're going to pay back at the end of 15 years. It's also common for people to get confused on the fact that, well, we're not just going to pay the 240, plus a bunch of interest on top of that. But at this point in time, we have not yet incurred the interest. We've already got this obligation to pay the 240 because we are currently using that. However, we haven't used the money. Like it's similar as if we had rent. We can't record the rent expense before we've used the apartment or the building. So once we use the building, then we have incurred the rent expense. That's when we record that rent expense. So then, of course, we have a difference here. We have the cash that we received and we've got the bonds payable and that will be the discount. So the difference will be the discount. So the 198.44 plus the 41.516 will equal the debits of 240 will equal the credit of 240. How do we get the 41.516? It's the 240 minus the 198.484. That's the plug that we need in order for the debits to equal the credits. Also note the way that we thought this out is that we thought of cash first like we normally do and we thought of the bond that we've got to put out. And then we thought of the plug being the discount. That's how I would think through it. However, thinking through it in that way means that the discount is a debit and it's on the bottom. If you're gonna record this into a software that's gonna be great in you or something like that, then you probably wanna put the two debits on top. If this format helps you to go back and audit the information or helps you think through the information, I would think that is more important than having the two debits on top. So be aware of that. Now of course, if we posted this out then we would say cash has a debit balance. We're gonna increase the cash here by this 198.484 and it's gonna go up to 918.484. Then the bonds payable. We have a credit balance in the bonds payable. Bonds payable's a liability down here. So it has zero, it's gonna go up by the 240 to the 240 credit balance. And then we have the discount. So the discount is here. There's nothing in the discount. We're gonna debit the discount by the 41516. So note what we have here. We've got the bond payable, which is the 240 and we have the discount. So that means that the carrying amounts of the bond then would be the 240,000 minus the 41516, which would be the 198.484. That's the amount of cash that we've received. Now a couple of things to note. Remember that we're not gonna pay off the 240 till the end. We will be making interest payments semi-annually, paying the rent similar to paying the rent on a building. But we also have this discount. And what are we gonna do with that? We know that at the end of 15 years that discount's gonna have to go away because after 15 years, we're gonna pay back the 240,000. And we can't have this discount like hanging around on the books when there's no bond related to the discount. So we need to get rid of this discount somehow over the time period. So it has to go away somehow, some way. So what we're gonna do is we're going to basically amortize that, there's a couple of ways we can do it. The easiest way is a straight line method. And if the amortization is immaterial and that it will not materially affect the decision-making, then the straight line method would be an easier way to go to amortize the discount. And it would be calculated similar to depreciation in that we would just take the amount of the discount. We're gonna divide it by the number of periods and just amortize it at the same period in which we pay these interest payments. So in that way, we would just write it off, meaning we're gonna reduce it by crediting the discount. And what are we gonna debit then? We're gonna debit interest on the bond. And that might seem weird. Why do we debit interest on the bond? But remember what the discount is. Why do we have a discount? Because it's basically a difference between the interest rate and the market rate. So really the difference is because of the difference between those rates. It really is interest that is the reason for it. And therefore it makes sense for us to write it off to interest as we go. So let's see what that would look like. So now we're gonna think about us in June 30th, record the bond interest and straight line amortization. So now we jumped forward in time. We issued the bond and now of course we're paying the rent on it. We only have to pay the rent twice a year. This is the rent has come up and do at this point in time so we will then have to pay it. So the first question we're gonna ask, well, is cash affected? And in this case, yeah, cash is. We're gonna pay the rent on the money that we borrowed and we're actually gonna pay it with cash. Remember that we are only paying the interest portion. We will not be paying the part of the principal as we would in many types of loan arrangements like a mortgage or like a car payment. So how are we gonna calculate this? Well, we'll pull up the calculator first and we're gonna take the face amount. Remember we're gonna take the face amount, not the issue price. This is gonna be the amount that is integrated upon on the bonds, the part that's written in stone. We already had this saying that we're gonna have to pay the face amount times the interest rate. Once again, it's the interest rate that's on the bond, not the market rate. Interest rate that's on the bond is part of the agreement times 0.06, 6%. That would give us 14.4. That would be interest for a year and I wanna stress that whenever we think about the interest rate, if I was to say that the mortgage rate on the interest is 5%, notice that that means 5% a year even though we pay the interest on a mortgage, for example, monthly. So we could break down the interest rate to a monthly rate by dividing it by 12 or we can figure out in this case, as we've done here, what the interest would be if the term was for an entire year and then break it down to what it's really over which is only going to be for six months. So six is half a year, I could divide by two or this would work for any fraction of a year. We could say let's divide it by 12 which is how many months are in a year. That's just how much rent we would pay per month and then how many months have passed since this date to this date, six months times six. And that would give us the 7,002. So that's how we're gonna take a look at the interest here. Now I'm gonna stop there and I'm gonna calculate the amortization. So that's how much of the cash we're gonna pay due to the interest on the face amount of the loan which was of course the face amount of the loan times the interest rate. Now remember that we have to get rid of this discount. So how are we gonna get rid of that? Well, we have to lower it. We're gonna have to credit it by something. Let's figure out a straight line method to credit it. So what we have here is we've got the unamortized discount. So if we take out our calculator, the face amount of the loan, 240,000. Minus the unamortized discount, the 41516. Remember that's the carrying amount. That's how much we bought. How much cash was received for the issuance of the bond. Now we're gonna have to reduce this 41516 over the life. So in order to do that, it's gonna look like this. We're gonna have the amortized amount 1384. How do we come up with that? Under a simplified straight line method, we're just gonna take that 41516. And I could say divided by 15, that's how many years. So divided by 15 and that would be how much per year. However, we're doing it semi-annually. So this is every six months or twice a year. So that would be for a year. So if I divide that by two, that would be the amount for one period being six months. Notice it is rounded of course here. So we've got 1384, 1383 point, blah, blah. So we could also do that. A lot of people will think about it this way. We don't wanna think about how many years. We wanna think about how many periods. So if it's 15 years, semi-annually twice a year times two, that would be 30 periods. So we can just take that same 41516 divided by 30 periods. That would give us the same 1384. And that means that our discount should go down from 41516 minus 1384 to this 4132. And then our new carrying amount, it's always gonna be the carrying amount will be the amount of the bond to 40,000 minus the unamortized discount, 4132, that give us the 199,868. So therefore, we are gonna credit the discount for the 1384. We're gonna reduce the discount here by 1384. And what will the debit go to then? It's gonna have to go to the bond interest. So the debit will be bond interest. Remember just like rent on a building, we're debiting the interest just like we would debit for the use of borrowing anything. And we're actually paying in cash part of that to the 7.2. And then the rest of that is the amortization of the discount, which of course is the difference between the market rate and the interest rate on the bond. So the 7.2 plus the 1384 is the bond interest that we will debit. So let's take this journal entry, let's post it and see what it looks like as we do that. So here's the same journal entry. If we were gonna post the bond interest, of course, we would be down here. It's an interest is an expense. Expenses all have debit balances. They only go up for the most part. We're gonna do the same thing too, which in this case would be another debit. So it goes up to here. What's that due to net income? Brings it down. So we had the 700,000. Expenses go up, income goes down. How do we calculate that? 700,000 minus the 8584. So this is when the income statement is affected when we expense it, obviously. And then the cash here will be a credit. So we have cash as a debit balance. We're doing the opposite thing to it, which is a credit. So cash is going down. So cash is gonna be reduced. And then the discount. So here's the discount has a credit balance and we are reducing it. So we're gonna reduce the amount by doing the opposite thing to it. And that brings us down to the new carrying, the new amount, the unamortized discount, which we calculated in the prior example. So now we're gonna move forward to 1231 and we're gonna do the same thing. So it's gonna be a very similar process. Once you calculate the discount on something like this, then it's always gonna be basically the same. We'll go through one more variation of it and it'll be similar as we go. So thinking through it the same way, once again, six more months have passed. Now we need to record the interest. We gotta pay like the rent, just like the rent has come around on the borrowing of this bond. So we borrowed, we got cash of 198 and the bond of course is for the 240. So is cash affected? We're gonna say, yeah, cash is affected because we're paying like the rent on the borrowing of the money. And therefore we're gonna calculate that. How do we calculate the interest? Well, we take the face amount, not the issue price, the 240,000 times and the interest on the bond, not the market rate, the one that's set in stone on the bond times 0.06 and that would be for a year and we only did it for six months. So I'm gonna do it the other way this time, that last time I divided by 12 to give us a yearly total, then multiplied times six to represent the six months passed. We can also just say, hey, it was half a year, one half, one over two. So we can just say let's divide by two and say that's the 7,002. So cash is gonna go down by the 7,002. We also need to think about, of course, the bond pay, sorry, the discount on the bond payable. That needs to go down. It's gonna go down at an even straight line method and we already calculated it last time. If we do it again, it's gonna be the same number, just like straight line depreciation. So if we were to think about that, we put the calculator up here and remember what we had then, the original amount of four, one, five, one, six divided by, we have 15 years semi-annually, 15 times two, 30, divided by 30, that gives us our amount that we came up with. It's gonna be the same each time. And therefore, if the unamortized amount was 40,132 before 40, 132 minus this 1384 means the unamortized amount will be the 38, 748, and then the carrying amount will always be the 240,000 bond less the unamortized discount, 38, 748, giving us the 201, 252, which will be the new carrying amount. That means that we are then going to credit the discount. We're gonna reduce the discount because it has a debit balance. We're gonna credit it, reducing it, and then we're going to debit the interest expense. So we're paying the interest expense just like rent. We are expensing the use of the money in this case and therefore, let's take a look at this in terms of us posting this transaction. So now we have the interest expense once again, the same transaction. And if we look at the bond interest, we have the interest expense from last time on the same year and we're gonna increase it. We're gonna debit it, expenses always go up with a debit balance. So now it went up to 17168. What did that do to net income? It brings it down. So here's the net income, brings it down, expenses went up, net income goes down. How do we calculate that? If the income credits 700 minus the expense, debit 17168 gives us the net income. Then what happens to the cash? It's gonna go down. We paid cash. Cash is a debit balance. We did the opposite thing to it, bringing cash down, bond discount, bond discount as a debit. We did the opposite thing to it, bringing it down to 38. Notice that this what we would keep on doing this, of course, for 30 times. And at the end of that 30 times then, this bond discount would go down to zero. And at the end of this 15 year time period, what would happen? We would pay off the bond payable at that time. So now we are now able to record journal entry for the issuance of a bond at a discount, explain the effect of recording the journal entry on trial balance accounts, calculate the interest payment and amortization of discount using the straight line method, record the journal entry related to interest payment and amortization of bond discount, explain the effect of recording the journal entry on trial balance accounts.