 Hello, and welcome to this session in which we would look at a CPA exam question that deal with an investment and that investment is available for sale, it includes accrued interest, it includes bond investment amortization. So you have three different concepts going on at the same time that deals with a bond and we talk about the bond as well. So you have to understand actually four different things, how bonds work, how accrued interest work, how you amortize any discount or premium when you make an investment and it's an available for sale bond. Before I start I would like to remind you if you are studying for your CPA exam to check out my website farhatlectures.com. I do have supplemental material for your CPA exam or if you are taking your accounting courses. Now I don't replace your Wiley, Glyme, Roger, Becker, Sargent or any other course you are taking. My job is to supplement. I can be a very good addition to your CPA course where I can add 10 to 15 points to your CPA exam score. I don't short change you in the explanation. In other words, CPA prep courses they assume you know you have a certain level of knowledge. I don't assume anything. I explain everything in details from scratch. If you're an accounting students I do have accounting courses as well. Please connect with me on LinkedIn, subscribe to my YouTube. I always post videos and if you like them please like them and share them so you can help others as well as on Instagram and Facebook. So let's go ahead and start to dissect this problem that involves again many many aspects of different concepts. So on November 1st, 2014 Adam Company purchased Maggie Inc. They purchased the Maggie bond. It's a 10 year 9% bond with a face value of 600 000 for 540 000. You want to make sure you understand everything in the first statement. We have an investor and an investee. An investor and purchase bonds basically made an investment. The investor is Adam Company. They purchased the bond. The bond has a face value of 600 000. They purchased them for 540 000. First of all this bond is at a discount and the discount is 60 000. That's the first thing we know. And the date is important here. The date is November 1st. An additional 15 000 was paid for the accrued interest. And be careful here how the information is given. Here you are told additional interest was paid. So it's not part of the 540 000. The information could be given as rather than give you 540 000. They can say you paid 555 000 including 15 000 of interest. This is the same information. Here in this question I made it easy for you. You said you paid 540 000 for the bond and additional 15 000 for the accrued interest. Now once you say you paid for the accrued interest it means this bond was purchased in between interest payment. And let's see. Interest is payable semi-annually on January and July. Indeed it was purchased between interest payment. So here's what you need to understand. This is the timeline. Interest for this bond is paid on January and July. This is when the interest is paid on July 1st. You purchase the bond. Adam purchased the bond in November 1st. When you purchase the bond the buyer of the bond Adam will have to pay the seller accrued interest. Now Adam happens to pay the seller 15 000 of accrued interest. Now is this the correct amount or not? We're going to find that out in a moment. But you have to understand that the buyer will pay that accrued interest. The bond with shore on July 1st 2021. This is important because we need to know how are we going to amortize the discount. Remember we have 60 000 of discount. Adam uses the straight line method for amortization ignoring income taxes. The amount reported in Adam's 2014 income statement as a result of the available for sale investment is how much. Simply put Adam is going to receive interest from this bond. How much of that interest or how much interest revenue would Adam record on his income statement for the year ending 2014? That's the question and the answer are 10 500 15 000 18 000 or 27 000. How would you approach this problem? Well first let's compute the interest for the whole six month. Simply put if Adam purchased the bond on July 1st well if Adam purchased the bond on July 1st it's going to be 600 000 times 0.045. Why 0.045? The bond pays interest at 9 percent. We're doing it for we're computing the amount for six month. It will be 27 000. And the answer is 27 000 if if Adam purchased the bond on July 1st at face value. So that's not the case here but now we know the total interest for this period cash interest is 27 000. Now remember Adam purchased the bond on November 1st. So that's the total amount actually that's the total amount of cash Adam would receive because when Adam on December 31st the issuing company whatever that issuing company is will pay will pay 27 Maggie will pay will pay Adam 27 000 in cash. But is this going to be the interest revenue and the answer is no. Why? Here's why. First of all Adam purchased the bond on November 1st. On November 1st. What does that mean? It means part of this cash interest that that that Adam received should not be interest revenue. Why not? Because someone else held the bond for July, August, September, and October. So someone held the bond for four months. What does that mean? It means Adam will have to back out. Although Adam received 27 000 in cash Adam will have to back out the accrued the interest that was accrued that someone else will need to record that revenue on their income statement. So simply put what we're going to do we're going to take 27 000 and divide 27 000 by six months. So we're going to take 27 and divide 27 000 by six months. So let's go ahead and see how much interest per month 27 divided by six. So per month it's 4500. Now Adam did not own the month did not own the bond July, August, September, and October. So if we multiply this by four that's going to give us 18 000. So this 18 000 is simply the accrued interest. Now when Adam purchased this bond Adam only paid 15. You might be saying why? Wait maybe the seller was so desperate they said okay I will forgive a one month worth of bond for you. It doesn't matter. Adam held the bond for two months. Therefore Adam will need to deduct 18 000 from the cash in terms of revenue. Although Adam received 27 000 18 000 of it is not really interest. So what Adam left with is nine thousand dollar nine thousand dollar in interest revenue. Well we don't have nine thousand as an answer we are missing one more thing. What are we missing? We are missing the fact that the bond has 60 000 of discount. When you buy the bond at a discount your interest revenue will be higher than the cash that you received. Although although you received 27 000 in cash if you compute the interest revenue the interest revenue would be higher because you received the discount. Now what's going to happen? Adam will need to amortize this discount for November and December. For those two months November and December this is how much you're going to amortize the discount. Now how are you going to amortize the discount? You're going to be using the straight line method. What does the straight line method mean? It means amortize it equally over the life of the bond. Now we need to know how long is Adam holding the bond. Well it's going to go from November 1st 2014 till the bond mature July 1st 2021. So let's kind of go real quick and count to see how long will Adam held the bond. For 2014 he's going to have two months for 15 16 17 18 19 20 and 21 so it's going to have 12 for each uh now 21 it's going to have six months for 21. We'll count 21 separately 12 12 12 12 12 12 months for 2020 12 months for 2020 and for 2021 it's going to it's going to mature in July. So if we're going to take one two three four five six we're going to have six full years so let's take six multiply by 12 that's equal to 72 so those equal to 72 month plus eight plus eight equal to 80 month. So Adam's going to have this bond for 80 month therefore he's going to amortize the bond over 80 month so 60 000 divided by 80 month it's going to give Adam per month 750 of discount being amortized so we're going to now do November and December we're going to multiply this by two. So in addition to the 9 000 Adam is going to recognize in revenue an additional 1500 in bond in discount that's going to be turned into revenue therefore after all said and done the answer is 10 500 the interest revenue that Adam will receive that Adam would record on the income statement. Once again real quick the total amount of cash is 27 000 if he held the bond for six month well he did not we'll have to back out the four month will keep us with 9 000 then we have to account for the discount the discount per month is 750 750 times two is 1500 so this is how we will solve this problem and the answer is 1500. Now if you're having any difficulty with these concepts don't sit for the exam yet you are not ready you have to understand how bonds work and you have to understand how bonds work from the issuer's perspective and from the investor's perspective in this problem we looked at the investor's perspective now you have to understand how to issuer account for this bond and this is where I would like to invite you to check out my website for hatlectures.com where I cover these topics in details whether it's from the issuer's perspective or the investor's perspective again if you're taking any of these accounting CPA prep courses I don't replace them I wish I can if I can I will I'll be charging you more than this nominal amount 29 99 is nothing based on the value that you will you will get don't shortchange yourself the CPA is a lifetime investment in your career put the exam behind you move on so you can succeed in your career good luck and most importantly stay safe