 In this discussion, we will discuss the discussion question of explain the journal entry for issuing bonds at a premium and the journal entries for interest and amortization. Support accounting instruction by clicking the link below giving you a free mug 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. If we see an essay question or discussion question like this and we don't know where to start we could start with just thinking about bonds what are bonds can we define bonds and hopefully that'll get us going so that we can expand from there. So when we think about bonds we are the ones issuing the bonds and that means that we're issuing them and we're going to get money. So we're issuing the bonds we're going to receive money for it. The bond itself is just going to be a promise to repay and give the rent on the money that we're receiving the interest payments. So the bonds can be a promise to pay back some principal amount and interest at the end of the bond or some stated amount on the bond the face amount on the bond plus any interest on the bond. So that's where we start and then we can think about I would think about the journal entry. So it's asking us for the journal entry here so we can just start to construct it and we can think well what we're trying to do when we have the bond is get cash. So if that's the case when we issue the bond we're going to debit cash that's going to be very sloppy journal entry over here but we're going to debit cash for some amount and then we're going to have the bond payable that we're going to pay back which is a liability. And those two things are pretty straightforward typically the bonds you can always think of it as like a thousand often they're issued in terms of thousands. And then the question is you know what is a premium or a discount in this case we're talking about a premium. What does that mean? I always think about it from the sense of if I'm the purchaser when I think about these discounts or premiums. So in other words if we have this bond here and we have it's a thousand dollar bond that's kind of like the sticker price on the bond and if it was a 10% interest rate bond then that's going to be the interest rate. Now if I paid anything less than 1000 I would call that a discount we bought it for less than the sticker price less than what's on the bond. If we paid anything more than the 100,000 we'd call it a premium in this case we're paying more. So we're going to say we paid something more like 1100 and that's what results in the premium. So here's kind of like the journal entry we would have if we would have purchased something. Now notice how useful it is just to make up numbers. These numbers are totally made up but it's useful to write down the journal entry and if you have an essay question possibly make up some numbers and write down the journal entry because then it's just a matter of describing the journal entry. So if we're going to issue the bond when we issue the bond we're going to debit cash because we issued the bond we're going to put the bond on books for whatever the face amount of bond is and then if it's issued at a premium we got more cash than is on the face amount of the bond and we would then have to credit the premium and that credit do we know if we need a debit or credit that's usually a confusing component because to know if it's going to be a debit or credit versus a bond premium versus a discount. Then we can get into well why would that happen so why would it be that someone would pay in this case someone's paying us more than the face amount of the bond and so this is always going to be the question with any kind of bond issuance and we just got to understand this to some degree and that's going to be the fact well it has to do with the interest rates this interest rate can't change and the amount can't change as it would if it was a note we would change basically if like a loan we would change the interest rate that's what we would haggle over but we can't change the interest rate here it's fixed so whatever interest rates on the market rate we have the market rate then it's going to determine whether it's going to be a premium or and or a discount why would that be well if if the market rate over here was 12% then what would happen is this if I'm this person I'm thinking of loaning money to the business giving a thousand dollars over here why would we do that because we want to get rent on our money we want to get a return and if we can give our money somewhere else and get 12% on a return then we're not going to give our money to to the business unless the business says well I'll give you this thousand dollar bond I'll give you a thousand dollars at the end plus 10% interest I know that's below the market rate therefore I'll accept something less so that would be a discount a premium on the other hand would be if the market rate was only 5% and this person could only go somewhere else and get 5% on the 1000 then they're going here they're going to say yeah I want to buy this bond for a thousand dollars and we're going to say no because we know that we're issuing 10% that's what's on the bond and we know you can only get 5% elsewhere so that means that we're going to have to issue it for something more so that means we want something more in this case we're saying 110 now what is that more how would you know what that more is it would be you'd have to present value the future cash flow payments to figure it out in other words the stream of payments that we're going to have here is going to be one the 1000 at the end and then we could say that there's going to be some series of payments which are going to be 10% of the 1000 some periodic payments semi monthly or semi yearly or yearly payments if we present value those those payments at the market rate then that's going to give us the present value and that's what will differ that's what will determine that difference but we don't need to do that calculation most likely in an essay question like this but we could explain that what would happen then of course now we have this credit on the books for a premium of a hundred dollars and we're going to have to deal with that throughout the time periods so throughout the time periods what's going to happen is we're going to pay interest and that interest you can think of it as pretty straightforward we're just going to pay whatever the face amount is times the interest and then we'll adjust it for whatever time period we're dealing with it's semi month semi yearly or over yearly or whatnot we'll enter that journal tree which will be a debit to interest expense and a credit to cash that's the actual cash will pay but we're also going to have to deal with this premium that we're going to have to amortize over the life of this bond so there's a couple different ways we can do that we could think about it in a separate journal entry and think about it that way and we would say well what's going to happen with the bond premium we're we could the easy way to do it is to just amortize it over the same life of the bond 15-year bond with semi annual payments over 30 years we'll amortize this and we could just take the straight line method which would just take that 100 divided by the 30 and that would mean that we're going to allocate that portion whatever we get over the life to interest expense so the journal entry there since this is a credit when it goes on the book we'd have to do the opposite we'd have to debit the premium and then we would credit interest expense which is a little bit unusual because then we would credit interest expense here which would make interest expense go down but note what really happening is we're netting it out against the payment that we're making we're making the payment at whatever the rate is on the bond and and we're netting out the premium why does that make sense because the premium is really a result of the difference between these two rates now that would be the simple method of amortizing we could use that the effective method would be the preferred method to figure out what the amount that we should be recording each time period the amortization of this premium and that would be using more of a fixed method it'd be similar to us using using an amortization table when we figure out the amount of loan payments to be allocated between interest and expense and the effective method is more precise because it's going to be better lined up to the matching principle so it should be more precise now if the difference between the effective method and the straight line method is not material it's very small doesn't affect decision-making then we can decide which one we want to use but the preferred method is the effective method but in essence the two journal entries we're gonna have then you're gonna sum this up this will be the journal entry to put the bond on the books and then we were gonna have a journal entry that we could do in two journal entries or oftentimes it's combined into one which will do basically two things it's gonna record the interest expense that we pay plus the amortization of this premium and that's gonna that's gonna include a debit to interest expense it's gonna include a debit to the premium for whatever amortization method we're gonna use each period and then we're gonna credit the cash that we're gonna pay and that's gonna be repeated for however many times that we have the loan payments for by the end of the loan will be left with just the bond payable because the premium will go away and then we'll finally pay off the bond payable and we'll do that by crediting cash and debiting the bond payable account