 In this presentation, we will take a look at the recording of a bond at a 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 than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks 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. The information will be on the left side. We're going to enter that into the general journal. We will then post that to a worksheet over here, the worksheet having a beginning trial balance that's trial balance in order, assets, liabilities, equity, income and expense, assets and green liabilities in orange, equity accounts in light blue and revenue and expense, dark blue, debits being positive, credits being negative, debits minus the credits being zero, net income is currently the credit of sales minus zero expenses, zero debits or 700,000 net income. So what we're going to have here is the issuance of a bond which will pay interest semi-annually. Number of years will be 15, face amount 240,000, issue price 198,484, the interest rate on the bond, the contract rate will be 6% and the market rate is 8%. So a few things to note just with the data here. So we have the face amount and the issue price versus the market rate and also we have the market rate versus the contract rate. Which one of these should we use? What's the relevance of these? Note that different problems if we're talking about book problems may line up this data a little bit differently. They may ask it in different ways although it is related. In other words, the difference in the face amount and the difference in the issue price, the reason there is a difference there is due to the difference in the market rate and the rate on the bond, the contract rate. However most problems are going to have to lay out the face amount and the issue price on the issuance of the bond because it's more difficult to derive what the difference should be to try to figure out what the difference is. So note that if we're looking at a book problem and we're talking about the recording of a journal entry, they're probably going to give you the face amount and the issue price. And then another in a time value of money problem which we'll look at later. We talked about well if we had these two interest rates how can we decide what possibly would be the issue price based on this information. So they're related but in this problem they're giving us the face amount and the issue price. It's also useful to know what's on the bond versus what's kind of not on the bond meaning the bond has 240,000 on the face of the bond. That's part of the bond. The bond has a contract rate on the bond of 6%. The bond does not have the issue price. That's whatever we sell it for just like any other thing. If we're going to sell stocks or bonds we sell for whatever we can get. And so this happens to be what we can get. The market rate is not on the bond. That's again determining, helping us determine what the issue price is and it's just whatever the market is, whatever we can sell it for. So if we think about this then we obviously have a face amount of the bond 240 meaning we are going to pay back 240 at the end of the bond 15 years. The issue price is what we're going to receive for it. What we're going to get for it now. And notice of course that the issue price is less than the face amount of the bond and that we would think is a discount. That's going to be the result of the discount. We can derive this discount by doing a journal entry with these two numbers. I would go through our same process first, is cash affected? Our first question all the time. We're going to say yeah we're going to get money because we're issuing the bond. So we have cash as a debit balance. We need to make it go up. We're going to do the same thing to it so I'm going to right click and copy cash. We'll put that up top in C3, right click and paste 123. The amount of cash we're going to get is going to be the issue price not the face amount of the bond. So this is what we are actually going to receive for it. And then we're going to say well we're going to owe something back at the end. It's kind of like a loan but we owe the bond back. That's a liability just like if it was a loan and it's going to go up with a credit. So this is a debit balance. I mean it's a credit balance account like all liabilities. We're going to make it go up by doing the same thing to it another credit. So I'm going to right click and copy the bond payable. We'll put that in C4, right click and paste 123. I'm going to indent that, go into the home tab, alignment, increase indenting. We'll be in the credit side in E4 and we're going to put the face amount this time that we're going to pay back. This is what we're actually going to pay at the maturity of the bond. Then there will be the difference and the difference is going to be a debit here. Since I didn't make this in order, I'm going to build this in the way that it makes most sense. If we want to reorder putting all the debits on top, we can do that later or just leave it the way it is in order because that's probably more helpful to understand what happened and how it happened. So we're going to have to put the debit here. It's going to be the 240 minus the 198, 484. I'm going to use our negative sum or our plug formula in D5 instead of equals we're going to say negative SUM, double click the sum function and then I'm going to highlight those cells, those four cells, D3 colon E4 and that gives us the 41, 5, 16. That's going to be the difference. In this case, that's the discount. So we're going to take the discount then, discount on the bonds payable and we're going to right click and copy and that's going to be here in C5, right click and paste 1, 2, 3. So again, notice I put this debit on the bottom as kind of like the plug formula. We could rearrange this and put the debits on the top. It's not necessary for the posting of it, but if you want to make it look nicer with the debits on top, that would be good. However, if it helps to see it this way, then it might be worthwhile to keep it this way, meaning it might be helpful to say, this is what we did first, thought about cash, then we thought about the bonds payable and then the difference is the plug here, the discount. So when we think about the discount in this terms, obviously the discount just means the difference between the cash we're going to receive and the amount that we're going to end up paying at the end of the bond term and it was given to us through giving us face amount and the issue price. Let's post this out and see what we have. We've got cash first, cash up top. We're going to be in I3 equals, we're going to say this 198 is going to bring the debit balance up in the debit direction. That's why we're issuing the bond to get the cash. Then we're going to credit the account, the bonds payable. So here's bonds payable. Here's bonds payable. We're in I6 equals pointing to that 41,516, I'm sorry, pointing to that 240,000, increasing the zero up by 242,240 in the credit direction. And then we've got the discount on the bond. Here's the discount on the bond. We're in I7 equals, we're going to point to that 41,516 and enter. So if we see what happened here, then the bond went up by 240,000 and we have this discount. In this case, the discount is kind of like a contra account. It's a contra liability account because what we're saying here is the bonds on the book for 240, that's what we owe. But really, it's got a value to us of 198,484. If we take the carrying value of 198,484, if we subtract out the discount. So we're saying here's what we owe back. Here's what the discount is. Here's really the carrying value, the sum of the two. So whenever we have an account that's kind of like a contra account, it's really because it's linked to this account. It's related to the bonds payable account. Why is this here? Notice it's here because of the difference in interest rates. Although this problem, we didn't have to think about the interest rates to get to there. What's really happening is we're saying we're going to pay back 240,000 at the end of the bond. But we're not going to expect 240,000 today. Why not? Because we think the interest payments are different from the market enough that it's going to cause that difference. So we will accept less money today because the market rate, in other words, is higher than the rate that's stated on our bond, the interest that we will actually pay. So that means that we're going to have to get rid of this amount, this 41,516. And we'll do that by expensing it to interest. And the reason is not because we're going to be paying interest on it, but because this is really a result of that difference of the interest rates.