 Hello and welcome to the session. This is Professor Farhad. In this session, we would look at CPA questions covering specifically far. And the topic is the difficult, the dreaded topic bonds. Bonds is also covered in my intermediate accounting course and details. So how can I help you? Well, if you are taking a CPA course, they do cover bonds, but they do cover it in a review fashion. On my course, intermediate accounting, I cover bond in details. I'll explain everything you need to know about bonds from A to Z and I'll prepare you well, whether you're taking the CPA prep course or the CPA exam. So the reason I'm telling you this is because in this session I'm going to go over a few questions, answer the questions, show you how to approach these questions. But if you don't understand bonds inside out, it's very easy to fall off the wagon when it comes to bonds. And bonds is an important topic. So if the AI CPA software notices that you are not answering bond questions correctly, there is more likely than not a chance that you will get less than 75. Anyhow, I just would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting audit finance tax as well as Excel tutorial, which eventually it's going to be tested on the CPA exam. If you like my lectures, please like them, share them. It doesn't cost you anything. If they're helping you, it means they might help other people connect with me on Instagram. On my website, farhatlectures.com, this is where I have those additional practice and resources that's going to help you master what you need to master. For example, in intermediate accounting too, I cover this topic bonds way, way in details. If you're looking to improve your grade or increase your understanding or get some supplemental material for your CPA exam. Again, I don't replace your CPA prep course. I supplement it. I am a support to what you have. I explain in detail much, much more than they do. However, I have a minimal subscription that will help you increase your grade by 10 to 15%. Beta Inc. issues a bond with a stated rate of 5%. The bond will sell at a premium if. So here they're asking you when will the bond sell at a premium if the stated rate is 5%. I would say this is a basic understanding of bonds. So if I am your instructor and I'm giving you an exam about the bonds and you cannot answer this question correctly. It means you don't even know the basics of bonds. Here's why. Well, let's see if we, let's see how we answer it. The bond will sell at a premium if the market interest rate is above 5%. Is that true statement? Is one a true statement? And the answer is no. If the market rate, if the market rate is greater than 5%, which is greater than your offering, then your bond will sell at a discount. So you need to know that immediately one is out. One is out. This one is out. This one is out. All we have to find out now if true, if two is true, the bond will sell at a premium. If the bond pays interest semi-annually rather than annually. And there's no way. If you get this, if you answer two is correct, then you have no understanding of how bonds work. It doesn't matter how often the bond pays the interest whether semi-annually or annually. It doesn't affect if it's going to be sold at a premium or a discount. It will sell at a premium if the market rate is less than 5%. If the market is offering 4% and you're offering 5%, your bond is offering 5%, then you will sell at a premium, which is none of these statements will comply. Therefore, the answer is D. So simply for the reason I'm giving you a basic question just to tell you if you get this question wrong, you have no understanding of close to zero understanding about bonds. So make sure again, I know I'm going to be inviting you again and again to my website. There's nothing else I can do except to tell you. Go to my website if you want to really learn the basics and practice. Let's take a look at this question on July 1st, year one, Google issued 8% bond in the amount in the amount of half a million which mature on July 1st, year 11. The bond were issued for $468,500. It means they were issued at a discount because it's below the par value and the market is 10%. It yield 10%. Interest is payable annually on June. So the interest is paid annually. Google Corp uses the effective interest rate method to amortize the discount. That's fine. How much interest expense should Google record on December 31st? So here they're asking us how much interest expense and it's on December 31st. How do we compute the interest expense if we are using the effective interest rate method? Well, the interest expense using the effective interest rate method is by taking the beginning of the period book value. The beginning of the period book value is $468,500 because the bond was just issued. So that's the book value multiplied by the market rate, which is 10%. That's going to give us $46,850. Be careful. Be careful. We're being asked on December 31st. The bond was issued July 1st. And this is a common theme that you will see on the CPA exam. So be careful about the date. So you only compute in this 4.5, which is half a year, which will give you $23,425. Therefore, interest expense as of December 31st is $23,425. So simply put, let's start to build the entry, interest expense, $23,425. Okay, so we saw how we get to here. Now, that's the interest expense. Interest expense, interest payable, that's the entry. How much is the carrying value of the bond on December 31st, year one? December 31st, year one. So what happened is this. Let me pull the calculator here because we're going to be using the calculator. They're asking us about the carrying value. What's the carrying value? Well, it's the beginning of the period book value, which was $468,500. Then what's going to happen as we amortize discount, we add the amortize discount to the bond. Okay, so the question is how much discount did you amortize from July 1st till December 31st? So now we need to go back and kind of think about how are we going to work this. How much interest expense did we have? We had $23,425. Now, what is the interest payable? Because we're not going to be paying this interest on December 31st. That's why I'm going to be crediting interest payable, which is the cash amount. How much cash are you going to pay? Well, the bond has a par value of half a million times 8%, let's see, half a million times .08. That's 40,000 times .5 because by December 31st we're only responsible for half. Therefore, interest payable is 20,000. Well, guess what? The difference between interest expense and interest payable is the amount we are going to, the discount we are going to amortize. So we are going to amortize discount of, the difference is 3,425. Now, this is the amount that we're going to be amortizing as a discount. What does that mean? It means if the bond had a value, when we started the period of 468,500, then we amortized 3,425. 425. How much is the, how much is the, what's the value? Let me just do the computation. 468. At this point, I know it's going to end up with 25. The answer is A, but if you have time, just double check your computation. Plus 34,25. 471,925. 471,925. And that's 25. That's how I know the answer is A because it's end with 25. Therefore, the answer is 471,25. Simply put, as time goes by, you amortize the discount. As you amortize the discount with your entry, as you record interest expense, you add the amortized discount to the book value. Now, the book value or the carrying value is 471,925. Now, again, this was on December 31st. Now, when you pay, when you make the payment on June 30th, you add the amount of the amortization, the amortized amount, then your book value goes up. It keeps on going up until it reaches at maturity. The bond goes back to its bar value. So that's why it's very extremely important because bonds, they have many moving pieces. You have to know how to compute your interest expense. That's one computation. You have to know how to compute your interest payable. So notice, your expense is 23,425 is more than what you are paying, which is you're going to be, if you were paying, you're only paying 20,000. The reason is because when you issued the bond, it was issued at a discount. So the discount is extra expense that you have to expense over the life of the bond. So those are things that you have to understand fairly quickly, fairly quickly. So simply put, because this is a discounted bond, the interest expense will be greater than the cash amount that you pay. Why? Because right from the get-go, let's see what happened right from the get-go. 500,000 minus 468,500. Let's see, 500,000 minus 468,500. You had a discount of 31,500, which is technically interest expense that you have to expense over the life of the bond. And what we did is we expensed some of it in this period. Let's take a look at this question. We don't need the calculator anymore. The amortization of a bond, the premium. Now we're looking at a bond premium each period with impact the financial statements in which of the following way. Interest expense being greater than the amount of cash paid for interest. Hold on, I just said this. Well, yeah, I said this for a bond that's issued at a discount. Well, is that true for a bond issued at a premium? No. Interest expense being greater than the amount paid for cash is for a discount bond. So if I change this word to a discount, then this answer will be correct, but that's not the question. Cash paid for interest being greater than interest expense. Hold on a second. What we're saying here is interest expense is less than the cash. Is this correct statement for a premium bond? And the answer is yes. In a premium bond situation, in a premium bond situation, so let's assume this was a bond that was issued at 515,000. Let's assume this bond was issued for 515,000. In other words, we had 15,000 of premium. Then what's going to happen is when we compute the cash amount, the interest expense will be lower. So we'll be lower by, you know, let's assume 1,000. We amortize the 1,000. Therefore, we debit premium 1,000, and interest expense will be 19,000. So in a premium bond situation, the amount that you pay in cash, which is the interest payable here, is greater than the interest expense recorded. Why? Because you received upfront more money. You received 15,000, which can help your interest expense, which will reduce your interest expense. Therefore, cash paid for interest is greater. Yes, or interest expense is lower. I like to kind of follow statement A. So your interest expense is lower than your cash, and the answer is yes. Why? Because you received more money upfront. Interest expense and cash paid being equal? No. If the premium was being amortized using the straight line, it doesn't matter whether using the straight line or the effective interest rate method. Interest expense and the cash will not equal to each other in a premium bond. The interest expense will be lower. None of the above is correct. That's incorrect. B is correct. Interest expense will be lower. Once again, a lot of moving pieces when it comes to bonds. You want to make sure you are comfortable with those moving pieces. Otherwise, you will fall very quickly and not being able to answer the question correctly. And once you understand bond, again, on my website, it's fairly easy to answer these questions. Those questions will bring it on. It's really easy. So you have to have a good understanding. Which of the following is a correct regarding a bond-sinking fund? So what is a bond-sinking fund? A bond-sinking fund is when the company put money away. So what they do is when the bond becomes mature, when they have to pay the bond, they have the money to pay it. Why do they do so? Because again, bonds, they are large amount of money and they come do all at once. So that's why they do this bond-sinking fund. Let's see. Sinking fund account that are considered to offset current bond liabilities can be included with current assets. Yes, that's the definition of a current liability. A current liability is something that's going to be offsetting current assets. If you're going to be using liabilities to pay current asset, then it's a current liability. So although it's a sinking fund bond, sinking fund bond usually it's a long-term non-current asset. Generally speaking, it's a non-current asset. But since the money there will be benefiting a current liability, it will turn it into a current asset because you have to use it in the current period. Therefore, one is correct. We can take out B. We can take out D. Now all we have to find out if two is correct, then the answer is C. If two is incorrect, it's not correct. The answer is A. A bond-sinking fund is an example of an appropriation of retained earning. Is it an example of appropriation? Yes, appropriation means restricted. When you have a bond-sinking fund, you will tell the users you have to appropriate retained earnings. So if you're putting away $300,000 and a bond-sinking fund, you have to reserve retained earnings 300,000 because it's restricted for a specific purpose. So a bond-sinking fund is an example. Yes, therefore C is the answer. Again, this topic is an important topic on the exam and it's a very much covered topic in my intermediate accounting course. Once again, I would like to invite you to like this recording, subscribe, check out my website if you want to add 10 to 15 points on your CPA exam. Have a good understanding. Be comfortable with all these topics. Good luck, study hard and stay safe during those coronavirus days.