 Hello and welcome to the session in which we would look at bonds payable. Bonds payable is an important topic on the CPA exam and your intermediate accounting course. The reasons are very simple. Bonds involve time, value of money, it involves knowing about discount, it involves knowing about premium, it involves knowing about how to amortize the discount and premium and you might have to redeem the bond at either again or a loss. So there's a lot of things involved in bonds. If you are not ready, don't sit for the CPA exam if you have not mastered the bond topic. How can I help you? Well, if you're a CPA candidate or an accounting student for that matter, I strongly suggest you visit my website forhatlectures.com. Especially if you're a CPA candidate, I don't replace your CPA review course. I will explain the material differently. I will explain it in depth. I'll give you alternative explanation, alternative examples. I can be the most useful addition to your CPA review course. I can add 10 to 15 points to your CPA exam score. How? By explaining the material differently. For example, I'll just give you an example to show you how I can help you. Maybe your CPA review course spends two hours discussing bonds. I might have four hours. What does that mean? Well, you have more time. How is that going to help me? Well, the two hours, it's not going to help you if you don't understand the topic. You might have to spend my four hours. This way you understand the topic, especially a topic like bonds, then the CPA review course will be easier for you to deal with. Now, bear in mind, your risk to try me is one month of subscription. Your potential gain is passing the exam. Are you willing to take that risk? Try it for a month. It didn't work for you. That's fine. Cancel. That's your loss. It did work for you. You made an investment for the next 30 years of your life. And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other CPA sections as well as accounting and finance courses. Please connect with me on LinkedIn. If you haven't done so and on LinkedIn, you can take a look at reviews, people that actually used my system to pass the exam, like this recording, connect with me on Instagram and Facebook. So let's take a look at the first question and simply put, this question, I would say this is very easy. This is like not easy. If you understand the concept, it's very easy. If you don't understand the concept, it's very difficult. But this question will tell you whether you really know bonds or you know bonds. So if you get this question wrong, you are not ready. If you get this question right, it's a good start. So let's take a look at the question and see if you can answer this question for a bond issue that sells for more than the bond face amount. What does that mean? It means this bond is selling at a premium. The effective interest rate is what? So we're asking about the effective interest rate. So what do you need to understand? You need to know that a bond could sell at a premium discount or tar. You need to know under what circumstances the bond sells at a premium, under what circumstances it sells at a discount, and under what circumstances it sells at par. Well, here are the rules, and you have to know the rules. I mean, I explain them in details in my review course, but I'm going to explain them here for you because you really want to know them. So if you don't know them, well, you should not be sitting for the exam. So too many boxes. So this is the effective rate. Effective rate also called the market. And we're going to call this the coupon or offering. They go with many names, but something like this. So here's what's going to happen. Let's assume, let's put the coupon rate first. Let's put the coupon rate first because it's easier to coupon rate. And this is the, since they're using the effective, we'll use the effective or sometime it's called the market, or it says the bond yield that much. So here's what's going to happen. Let's assume the coupon rate is 8%. It means the coupon rate, it means how much the company is offering to pay the bond holder, 8%. If the market rate or the effective rate is also 8%, it means your bond will sell at par. Why? Because if you're offering 8% and the market is requiring 8%, well, your bond and the market bonds that are similar to you are offering the same thing. Therefore, the bond would sell at par. If the company is offering 8% and you're offering 6%, the company is offering 8% and the market is offering 6%, then your bond will sell at a premium. Why? Because you're offering the coupon rate is more than the market, more than the market. Your company is paying 2% more. Now, if the company is offering 8% and the market is requiring 10%, anything above 8%, now your bond sell at a discount. Why? Because you're offering 8% and the market is offering 10%. No one in the right mind will buy your bond for full price and get 8% when they can go to the market and get a bond that could pay 10%. So, for a bond issue that sells more than the face value, the effective rate must be higher. The effective rate must be lower. Notice here the effective rate, so we are in this scenario here, the effective rate to sell at a premium more than the face value, the effective rate must be lower. So, they will give us this answer, less than the rate stated on the bond. So, the rate stated on the bond is 8, so you're offering 8, and the effective rate is 6. So, the effective rate is less. 6 is less than 8, the bond will sell at a premium because you're offering more. So, the stated rate is also called the coupon rate, it's also called the coupon rate. So, this is, it goes by many names, stated rate, coupon rate, sometime it goes by the printed rate, it's the rate that's printed on the bond, sometime it's called the contract rate. So, they all mean the same thing, so they could have many names. And on my, on forhatlectures.com, I do explain this topic in details. So, I know this is, you would say, you went through a lot of explanation to answer this question, you have to understand this grid here, you have to have a good understanding of it. And you're going to have to, you're going to have to build up on this knowledge, so make sure you know this grid pretty, pretty good. Or did they really, the proceeds from a sale of the bond will be equal to what? So, simply put, when you sell a bond, when the company issue a bond, okay, when you, or when you sell a bond, how much do you get the proceeds from the sale of the bond? Well, you have to understand this is also an important basic concept. The bond is composed of two parts, two parts. Coupon payments. So, when you buy a bond, you're going to get coupon payments, and you're going to get the face value, which is the amount for the bond. You get two things, the coupon payment and the face value. The coupon payments are an annuity, they are an annuity. So, it's a series of payment, and the face value is one payment. So, to find the price of the bond, to find the proceeds, you have to discount those two. You have to discount. So, is it equal to the face amount? No, it doesn't equal to the face amount. Is it equal to the total of the face amount plus all interest payment? No, you don't get the all the interest payment, okay? The present value of the face amount plus the present value of the stream of payment, yes, you discount them. Notice what I said here, I said you discount them. Discounter means finding the present value. You have to find the present value of the coupon payments, and you have to find the present value of the face value. The face amount of the bond plus the present value of the stream of interest payment. No, you discount both, it's the present value of the face amount, which is the face value, plus the present value of the stream of payment. So, you add those two together at PV, the present value. So, why don't we look at a problem that illustrates this concept? Seaside issue a bond that has a stated rate of 11%. This is the coupon rate. This is how much they are paying. The face amount is 40,000, and it's due in eight years. Interest payments are made semi-annually. The market rate of this type of bond is 12%. Well, before I do anything, they're asking us to find the issue of the bond. Here what we know, we know that the bond is offering 11, and the market is 12. So, let me go back here. So, you go back to here and you would say, the company is offering 11%. The company is offering 11%. That's the company is offering 11% and the market is requiring 12%. The market is requiring 12%. So, you are paying less than the market. So, your bond is a discount bond. Your bond is a discount bond. That's right here. So, this bond is a discount bond. So, immediately, you know it's a discount bond. So, what can you do immediately? Actually, you can answer this question without performing any computation. It's not face value. 61,000 is a premium. 55 is a premium. The answer is 37,979. So, notice, if you got a question like this, it will take you literally a second. You don't have to do any computation, but I'm going to do it. I'm going to perform the computation to show you that the answer is 37,979. The answer would be 40,000 if 11% for the coupon and 11% the market of those two equal to each other, or 12 and 12. If the company is offering 12 and the market is 12, the bond will sell at 40,000. It will sell more than 40,000 if your offering rate, your coupon rate is higher. So, you are offering 11 and the market is offering 9. It will be either A or C, which is that's not the case here. I'm not saying 9 will give you those answers, but the offering rate is more than the market rate. So, let's find the price of this bond. Remember, the bond is composed of two parts. First is the face value. So, we're going to discount the face value and we're going to discount the payments. How do we compute the payments? The bond is paying 40,000 times 11%, but we get paid twice a year. So, we divide this by and multiply this by one half. So, it's 40,000 times 0.11 times 0.5, which is one half. So, the payment is 2,200. That's the payment. And this payment, so we're going to have the payment of 2,000 equal to 2,200. And this is the face value. We have the payment and we have the face value. Let's just put them here. Now, what we're going to do, we are going to discount those two components, the face value of 40,000 and the payment equal to 2,200. Now, the period, what we're going to n, n is the number of periods. Although it says eight years since the since the since this bond pays semi-annually, n equal to 16, and we have to discount it at a certain rate. When we discount, when we go to the tables, we always use the market. Now, the market rate is 12, therefore, we have to use 6% because everything is semi-annually. So, remember, the n and the i, depending on how often the bond pays interest, it's semi-annually. You double the number of periods because you're going to get this 2,200 twice a year and you have the interest rate. You divide it by two. So, there we go. So, first thing, I'm going to go to my tables. And this is the present value of the face value because this is the present value of $1. And I'm going to go down to how many periods we said? 16, eight years, 16 periods. And the market rate is 12 divided by 2 equal to 6%. So, I'm going to look across and the present value factor is 0.39365. So, we're going to multiply this by 0.39365. And that's going to give us 15,746. Now, for the payments, I have to go to the annuity table. So, the present value of annuity. Okay? And now, again, I'm going to use the same n, n equal to 16 and i equal to 6. And the factor is 10.10590 times 10.10590. And that's going to give me 22,233. And as a result, if my math is right, I'm going to end up with 37979. It looks good. 7973. Yeah. So, the answer is 37979. Now, if you are not familiar with the time value of money, stop. You don't learn bonds if you don't understand the time value of money. Once again, farhat-lectures.com. The first thing I do in my courses, the first thing I do, when you sign up for my subscription, I'll do two things. One is basic accounting. I'll take you through the basic accounting concept. Two, I will teach you the time value of money. So, before you start my course, I advise you to look at those two before you start your actual CPA review course. Let's take a look at this question. Straight line amortization of bond discount or premium. A, can be used for amortization of bond discount or premium in all cases and circumstances, it's not necessary. Cannot be used in all. That's not a true statement. Provides the same amount of interest expense each period as does as the effective interest method. Now, it does not provide, you have to be careful here. The same amount, it's going to be misleading. Each period, it's not the same amount each period. So, be careful. It's the same amount, but not each period. Therefore, B is out. It's appropriate for deep discount. It's not appropriate for deep discount. So, that's why it's not appropriate in all circumstances. Take this one out and by process of elimination, D is the answer, but double check to make sure D makes sense to you. Provide the same total amount of interest expense over the life of the bond as does the effective interest rate. Yes, it does provide the same amount of interest, but not each period over the life of the bond over 10 years. It's the same amount, but not from period to period. From period to period, they differ. They differ. So, the answer is D isn't David. Let's take a look at this question. What is the annual stated interest rate on the bond? So, you're giving an amortization schedule and you need to be very familiar with this amortization. You need to be very familiar with this amortization schedule and this is the cash payment. This is the effective rate. This is the decrease in the balance and this is the outstanding balance of the bond. I can ask you so many questions about this table. For example, I can ask you what is the face value of the bond? Well, the face value of the bond is 200,000. I can ask you, is this a premium bond or a discount bond? Well, you need to understand the balance is starting at above the face value. It's a premium bond. I can ask you, here they're asking you, what is the stated rate? What is the stated rate? Well, the stated rate is, we're going to find out what the stated rate is. Give me a second. Let's talk about, we'll hold on that. I can ask you, what is the market rate for that bond? Okay, what's the market rate? Well, the market rate is what? The market rate is taken, this number 207,020 times x, well put x twice, times x should equal to 6,211. So, what number by what rate you multiply 207,020 to get you 6,211? Because this is the interest expense. The interest expense is the bond beginning of the period face value times the market rate, and you can find what what's the market rate is. They're not asking us about the market rate, they're asking us about the stated rate on the bond. And we know that the stated rate, we know that the stated rate, it's higher than the market rate. Why? Why do we know this? Why do we know this? Because the bond is selling at a premium. So, how do we find the stated rate? Well, we're going to take the face value times x gives us the cash payment. This is the stated rate. The stated rate gives us the cash payment. If that's the case, what did we multiply 200,000 by 200,000 times what equal to 7,000? Well, that's equal to 3.5, but you have to be careful. You have to be careful. 3.5, but you have to be careful because this rate is, notice the payment is done twice a year. June 30th, December 31st, 2021. Therefore, the rate is 7%. So, simply put, if we take 200,000 times 7% times 1 half times 1 half, that's going to give us 7,000. Therefore, the stated rate is 7%. Now, if I ask you, what is the effective rate or what's the market rate? Well, it's not going to, it's, well, it's going to be less than 7%. So, it's, this is incorrect. It's going to be, I would say, approximately, let's see the effect. So, what did we, let's find the effective rate. So, 207, 020 times x equal to 6211, x equal to 6211 divided by 207, 020. Let's find what the effective rate is, and I already told you it's going to be less than 7. Why? Because this is a premium bond, but let's find out exactly how much equal to. Let me pull my calculator here. So, 6211 minus 207, 020. Let me reset here. 6211 divided by 207, 020. That's equal to 0.03. Remember, I have to multiply this by 2. It's approximately, I multiplied by 3, but I have multiplied by 2. So, it's approximately 6%. So, 0.03300 times, I multiply notice by 3. So, the answer is the effective rate is 6%. So, what I just said, on this graph alone, I can ask you 10 to 15 different questions. What does that mean? It means you have to have a good understanding about a bond amortization schedule, a bond amortization schedule, and I'm going to disclose something. Maybe I should not disclose, but maybe due to the passage of time I'm allowed to disclose it. When I took my CPA exam, I would say, long time ago, 2003, I don't remember, it doesn't matter. Long time ago, I still remember, one of my simulation was to prepare a bond amortization schedule. So, expect to know how to prepare a bond amortization schedule on the exam day, whether using the effective interest rate method or the straight line method. And this is what I can help you with, farhatlectures.com. This is what I can help you with. I can explain this concept to you in details. So, there's a lot of information to know about a bond amortization schedule. This question, how would the outstanding balance, which is the book value of a bond payable, be affected by the amortization of each of the following? Simply put, it's asking about this bond amortization schedule. So, you could ask you, if you understand bond amortization schedule and the journal entries, then you understand bonds. So, how would the outstanding bond payable be affected by the amortization of each of the following? What happened to the premium? So, if you have a premium bond, what happened to the bond balance? Okay, well let's take a look at this. This is a premium bond. What's happening to the outstanding balance? It's going down. Well, knowing this, the only answer is D, because that's the only place where it's decreasing. And what happened to the bond, if it's a discount bond, if it's a discount bond, the bond actually will start, like if it's a discount bond, will start at 195, and it will keep on going up to 200,000. So, the discount bond will start at below the face value. It will go up to the face value. It will increase to the face value. A premium bond will start above and will go down. Therefore, the answer is D. Actually, this is an easy question because once you know the premium is a decrease, it's the only option. Once again, what I'm going to have to tell you to do is, advise you to do is, take a look at my website. I can help you understand the material better, if not better at least differently than your CPA review course. Take a look at it. Your risk is one month of subscription. 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