 Hello and welcome to this session in which we would look at amortization of bonds using straight line method, whether we have a premium or a discount bond. In the prior session, it's very important to review to know what is a bond, how to find the price of a bond. We'll review in this session just in case you need that additional material and amortization using effective interest rate method, which is the GAP method. In this session, we would look at amortization using the straight line method. Now the best way to illustrate this concept is to actually look at an example. On January 1st, Adam Company issues $100,000 in bonds due in two years with 8% interest payable semi-annually. At that time, the market rate for such bond is 10%. Well, first of all, how much is Adam's bonds paying semi-annually? Well, they're paying $4,000. 100,000 times the stated rate, the offering rate times one half because it's paid semi-annually and that's always going to be the same. Well, will Adam's bonds sell at a premium or will Adam's bonds sell at a discount? Adam is paying 8% less than the market of 10%. The bond will sell at a discount. How do we find the price of the bond? Well, the bond is composed of two things. It's composed of the face value, which is $100,000 and composed of four payments. One, two, three, four because it's a two-year four payments and each payment is $4,000. Each payment is $4,000. Now what are we going to do to find the price of this bond? We're going to discount the $4,000 and we're going to discount the face value using the market rate. The market rate annually is 10%, semi-annually is 5%. Let's do that. So we're going to go and first discount the 100,000. We're going to go to the present value of a single amount because we only get we have to pay the 100,000 only once in four periods at 5%. The rate is the present value factor point A2270. Therefore, the 100,000 worth the day, $82,270. Then we're going to discount the payments of $4,000. We have four payments. We're going to go to the annuity table, ordinary annuity, and we're going to be using four periods, 5%, and the factor is 3.54595, and that's going to give us $14,000. So if we discount those four payments, they're going to give us $14,183. Together, it's going to give us the price of the bond, $96,453.80, or the price is 96.453%. First, let's find the amount of the discount. Well, the face value is 100,000. We only receive 96,453.80. The discount is $3,546.20. The discount is a contra liability. And what are we going to do with this discount? We're going to amortize it to interest expense. So it's going to increase our interest expense. How much it's going to increase our interest expense? Since we're doing it, since we are amortizing it using the straight line, it's going to be divided by four. So simply put, we're going to debit cash, $96,453, credit bonds payable, $100,000, and we're going to amortize the discount over four periods. Now, before we look at the amortization, I would like to remind you whether you are an accounting student or a CPA candidate. Take a look at my website, farhatlectures.com. My motto is saving CPA candidate an accounting student one at a time. I don't replace your CPA review course nor your accounting course. I provide you with additional resources, useful material that's going to help you do better on your exam, on your courses, especially the CPA exam. Your risk is one month of subscription. Give it a try. If you like it, you keep it. If not, you cancel. Your potential gain is doing better. If not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. This is a list of all my accounting courses with material such as true, false, multiple choice questions and exercises. My CPA material is aligned with your Roger, Wiley, Gleam, and Becker. So it's very easy to go back and forth between my material and your CPA review course. I also give you access to the 1500 previously released AICPA questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation like this recording, share it with other, connect with me on Instagram, Facebook, Twitter, and Reddit. So what are we going to do with this discount? We're going to amortize it over four period and each period we're going to amortize to interest expense 886.55. Let me show you what it looks like. We're going to have a discount. Discount, again, is a contra liability. And we're going to start with $3,546.20. And each period, each period means each with each interest payment, we're going to reduce the discount, 886.55. And as we reduce it, as we credit the discount, we're going to debit interest expense of 886.55. And we'll do this for four times, the discount will go away. Let's take a look at the amortization schedule. We start with 96.453. Well, since it's a discounted bond, it's 100,000 minus any amortized premium happens to be at the beginning $3,546.20. And that's gave us the 96,553. Now we're going to make our first interest payment. The interest payment will be composed of two things, which is in total $4,886.55. $4,000 is the cash amount. And 886.55 is the amount we're going to amortize. So the interest expense is $4,886. We're going to debit, sorry, we're going to credit the discount, as I showed you, $886. And we're going to credit cash. What would the second payment looks like? The same. That's why it's called the straight line method, $4,000. We're going to amortize $886. And the interest expense is the cash plus the amortization. So let's take a look at this slide and make some overall observation. The book value, the carrying value or the book value of the bond is increasing to 100,000 because it's below. It's increasing by the amount of the discount we're amortizing. Interest expense is always the same. And that's by nature the straight line method. Interest expense is higher than the cash payment. Why? Because initially, initially we received less money than the 100,000 than the face value. And the discount is eventually fully amortized, specifically to interest expense. And the bond goes back to its face value. Let's take a look at another example where the bond sells at a premium. Well, it's the same bond. However, the market rate is 6%. First, we'll start with the cash payment. The cash payment is the same $4,000. Remember, Adam is offering 8%, less greater than the market. The market is offering 6%. Therefore, Adam will sell his bond at a premium. Okay, let's compute the premium. We're going to discount the face value using the single amount table for periods. The market rate is 6. It means we divided by 2 equal to 3%. And the amount and the factor is 0.8849. That's going to give us the present value of the face value. Then the $4,000 will be discounted at for 4 periods, 3%, 3.7171, which is going to give us 14,868. Therefore, the bond sells at 103,717, or 103.717%, which is a premium. How much is the premium? The premium is the difference between the cash and the face value, 3,717. Premium is an adjunct liability. We're going to divide this by 4 to amortize it over 4 periods since we are using the straight line method. And this is what the journal entry would look like when we actually issue the bond. After we issue the bond, we're going to have to amortize it. How are we going to amortize it? Well, we have a premium account. And in that premium account, we have $3,717.40. We'll divide it by 4. It's going to give us, for each period, 929.35. Therefore, as we are making interest payment, we are going to be reducing the premium, 929.35. But the premium will also be reducing interest expense. It's always going to be, it will reduce interest expense for us. So notice the debit to premium, the credit to interest expense. Therefore, as we make a payment of $4,000, our interest expense is only $3,070.65, because it's reduced by the amount of the premium. Therefore, this is what the first entry would look like, the interest expense, the cash amount, and the premium. And after that payment, the bond goes down to $1,027.88.05 by the amount of the premium. The second interest payment would look the same. The third and fourth, they would always look the same. And as we are making interest payment, the bond carrying value is going down. By the way, the bond carrying value starts at $100,000 plus the an amortized premium $7,717.40. And that's going to give us the original carrying value. Let's have some overall observation. The book value is decreasing because it's a premium bond. It's going to go down. The interest expense is lower than the cash payment. Why? Because we received more money upfront. It's a premium. The premium is eventually fully amortized against. It's going to reduce interest expense. Interest expense is always the same, and the bond will always go back to its face value of $100,000. Let's take a look at some overall comparison between the two. This is a discount bond. And for a discount bond, the book value is increasing. For a premium bond, the book value is decreasing because you start above and you go down. Here, you start below and you go up. Interest expense is the same. Interest expense is the same, whether it's a premium bond or a discount bond, if you are using the straight line method. Interest expense is higher than the cash payment. Yes. For the discounted bond, the interest expense is higher. For a premium bond, interest expense is lower. Discount is fully amortized. Premium is fully amortized. Bond is back to the face value. Bond is back to the face value. At the end of this recording, I'm going to invite you to go to my website, farhatlectures.com, and work additional multiple choice questions and look at additional resources. Again, my motto is saving CPA candidate an accounting student one at a time. Don't shortchange yourself. Keep your CPA review course. It's a great resource. Use me as a supplement. I do have additional resources. Invest in yourself. Your CPA exam is a lifetime investment. You only have to pass it once and it will pay you dividend for years. Good luck, study hard, and of course, stay safe.