 In this discussion we will discuss the discussion question of compare amortization options for a bond discount. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need then can be done on a YouTube page. We also include added resources such as Excel practice problems PDF files and more like Quick Books backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it. So if we see a discussion question like this or essay question like this and we don't know where to start we might just want to start with bonds what is the bond and that might help us just to pick up some points and get an idea of where to go from here. So a bond is going to be something that we're going to issue we're going to issue the bond for the company in order to finance the company and the bond is just going to be the idea that as contract that we're going to owe something in the future. So the bonds are typically a thousand dollars or so we can issue multiple bonds and there's going to be some stated interest rate and some maturity date and fixed interest typically on the bond. And that's what we are promising to pay in the future. So it's going to it's going to represent a liability to us. Now so that would be what a bond is now if we go into the discount then we can go and well what is the discount what does the discount mean. The discount is best to get an idea of and what you're going to do to it if you make the journal entry so it's useful to just say OK how does it how is a discount going to get on the books and then just write the journal entry for it and that might give you some points one and it'll give you a better idea of jogging your memory and would how am I going to deal with this bond. Where does the discount come from and how do I how do I deal with it. So typically what's going to happen when we issue the bond that's when the discount happens. So we're going to say that we're going to get cash because that's what that's why we're issuing the bond and we're going to issue the bond payable is going to be a liability. So we know the payable is going to be a thousand and then the question is well what is this discount come from. Well if we're the buying something I would think about it this way you know if the purchase price sticker price is a thousand dollars and a discount would mean that we bought it for something less than a thousand dollars. So that's the easy way to think of a discount a premium means we pay more than the sticker price and the discount means we pay less. Now we're the one issuing the bond here but I think it's usually easier for us to think of it as you know if we're purchasing something because we typically purchase more than sell probably so if we bought something at less than the sticker price it would be a discount. So if I paid nine hundred for it then we'd have the discount and that's got to be a debit to make us in balance right. So that so we can construct our journal entry like that and so I know this is ugly but we can construct the journal entry like that and then once you have that you can get an idea okay that's what the discount is what does it mean to amortize the discount how are we going to amortize it. Well that just means that the discount has to go away because what's going to happen over the life of this bond well the bond is we're going to pay back the interest and then we're going to pay back the principal but this discount has to go away somehow because at the end of the day we can't have it there anymore. So what we're going to do is we're going to write it off to interest at an interest expense. So the amortization then the journal entry for amortization is simply going to be this is this is a debit we need to make it go away over the life of this thing so we're going to credit it and then we're going to debit interest expense. And then the question is well why why would we put it to interest expense what is this journal entry I don't see anything had to do with interest we just said that we sold it at a discount maybe we just sold it at why did we sell it at a discount well we sold it at a discount because of the interest rates would be different. So the reason we're selling it at a discount is because the market rate is different from the stated rate. So our stated rate on the bond is 10% if the market rate was something like 12% well then whoever's given us the thousand dollars we're trying to sell a thousand dollar bond but we can't because the market is saying hey you're only paying 10% I want to go somewhere else and get 12% why would I pay for your bond. So what they're saying we're going to say all right well we'll give you our thousand dollar bond at $900 at a discount because of the interest rate. So that's going to be that's going to be our way our reason for having the discount our reason for issuing it at a discount and and that's our reason for writing it off to interest because it's really a difference between the interest. Now the easiest way to do this is we're going to say if this was a if this was a two-year bond and it was semi-annual that would mean that there would be four time periods in this bond one two three four the easiest way to get rid of this discount is to just amortize it like you would like if a fixed asset you're just going to take it divided by the number of periods in this case four two years two semi monthly to my semi annual period so that's going to be two years and two times a year or four periods of six months and so we could just take that and divide it by four and then we'll just reduce this each time over over those four periods and that would be the easiest thing to do how would we do that but we would just credit this and we would debit the interest expense over this for four time periods now we typically would combine that journal entry with the journal tree to pay off interest which would be in this case one thousand times ten percent divided by two but you can think of them as two different journal entries too I mean it we could record them as two different journal entries their journal entry to get rid of this discount to amortize this discount would would simply be to credit the discount for whatever we want to amortize each time period and debit the interest expense and how much would we do that by well we can just take that 100 in this case and divide it by the four time periods and make an even straight line method now the straight line method is easiest to think about because that makes sense it's just we're just going to get rid of this by the end of time period it's easy to do and all the all the amortization amounts will be the same but it's not the preferred method because we should be kind of allocating this out based on the interest the interest to be more precise to be closer with a matching principle so so this method the straight line method is a method that can be used not preferred however it's more simple if the difference between the straight line method and the preferred method are which is the effective method or if small meaning it doesn't really affect anyone's decision making whichever method we use then we can use the straight line method typically otherwise if we think there is a significant difference we should use the preferred method which is going to be the effective method so the effective method it what that's going to do is we're just going to take the carrying value of of the bond and we're going to multiply that times the market rate and that's going to give us the amount that of interest we're going to amortize and basically the idea here is similar to if you're going to take an installment note and we note that if we look at an installment note we have we typically have the same payment oftentimes but the amount allocated to interest and principle will differ and that's because the the the value of the note or the principle of the note the unpaid off portion of the note it keeps on going down and therefore the amount of interest actually is going down because interest is a result of renting purchasing power and and the purchasing power has gone down well the same thing's happening here this is really this this discount is really a result of these differences in the rate so what we want to do is take the carrying amount each time and multiply it times the market rate and then and then adjust it for the period which in this case would be six months divided by two and that's going to it's going to result in the same thing on the effective method will meaning this one hundred will go down to zero at the end of in this case four time periods the life of the of the note but it's not going to do it in even chunks this time because it's going to do it in accordance with the interest rate as compared to the carrying value of of the bond