 Hello, in this lecture, we're going to work a problem related to issuing bonds at a discount. We are going to amortize the discount using the straight line method for amortization as we post the interest throughout the first year of the bond. 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. So we're going to have the information on the left hand side. We're going to post that information or record the journal entries related to this information in this blue section here. Then we will post that information to the center section of the trial balance so that we can see what's going to happen within context of trial balance in this quick trial balance we have over here, which has assets in green, the liabilities in orange, then the equity and the income. We're saying that we just have net income in this case, we're just going to see sales right here. So we have some context as to what effect will be on the income statement as we post these transactions here. We can see that we are in balance by the fact that the debits are represented with positive numbers in Excel, the credits with negative numbers and therefore the debits minus the credits mean that they are at equals in that the debits minus the credits equal zero. We'll post our transactions here, then we'll see the ending trial balance and we will see the effect on the transactions over here. We also have a worksheet where we will be calculating the straight line amortization of the discount. All right, so let's see what we have in our worksheet. We're going to journalize, record journal entries and post to the trial balance. So first we're going to issue bonds which pay interest semi-annually, so the interest is going to be paid out semi-annually. The number of years of the bond, 15-year bonds, face value 240,000, issue price 198,484. The interest rate on the bond is 6% and the market rate is 8%. So let's break that down a bit and then record this out. What this is saying is that we're issuing a bond that has the face amount of 240,000. The bond is us issuing the bond, so we are the ones that are basically getting a form of a loan by giving out the bond, receiving money. The face amount of the bond is 240,000, therefore we are going to receive money today and we're going to pay out 240,000 in the future and the interest that we're going to pay for basically this loan is 6% which we're going to pay semi-annually. So unlike basically a home mortgage loan which would be paid monthly, we're going to pay this twice a year rather than each month. Now the issue with a bond is that if it was a note, then what we would do is probably manipulate the or change the interest rate to match whatever the market rate is. So if we are an investor and we can put our money into similar assets and get a better return, then we will and in this case obviously if we're getting the loan, then we would usually change the interest rates in order to have a competitive rate on the market. The bond however, you might want to think of it as having already basically been written. So if we have a bond that's basically kind of already written at 240 face value 15 years on the bond and the rate is 6%, that's already there so you can think of it as already being set in stone. We can't change that therefore if we cannot change the interest rate which is what we would normally change in a note in order to be competitive on the market, the thing that we can change then is how much we sell it for. So even though we're going to pay 240,000 back after 15 years plus interest of 8% because an investor in this current market could get a similar note at a market rate of 8%, we are going to have to do something in order to get our bonds out there in order to get the money. What we can do instead of lowering the rate on the bond or increasing the rate of the bond to match the market instead of being able to do that, we can lower the amount of money we're going to receive upfront in order to issue the bond. So in this case, we are going to say, okay, I know you can get a better rate somewhere else in a similar loan therefore instead of having you pay us the 240, we will give you the bond for 198,484 and that will basically make up the difference of the fact that we could have this difference in market rates. So that's basically what's going to happen. So let's record this bond out. We're going to say that cash will be here. Is cash affected? We're going to say, yeah, we issued the bond. We are the one issuing the bond and we are receiving cash. Cash is a debit balance. We need to make it go up. Therefore, we're going to do the same thing to it, which in this case would be another debit. So I'm going to copy cash. We're going to put that on top, on our journal entry, right-click, paste it 123 and it's going to be on January 1st. Now the cash we're going to receive, remember, it's going to have to give it to us in the problem for the most part is 198,484 and again, how are we going to figure that? Well, we're basically figuring out what the difference between the market rate and the rate on the bond would be over the basically the life of the bond. So that's usually given in most problems related to bonds. So we're going to say this is 198,484. That's how much it's that we are going to receive on the bond. And then of course, we are going to give the bond, meaning we're going to owe money. We got money just like a loan and we owe it back out. That's going to be bonds payable. So we have bonds payable here. It's in the liability section, similar to a loan. We're giving a bond, which is kind of like a loan that we're going to have to pay back in 15 years. They have credit balances, liabilities do, and we are going to make it go up by doing the same thing to it, which in this case would be another credit. So I'm going to copy the bond in G6, right-click, copy. I'm going to paste that in C4, right-click and paste 123. Now we're going to put it on the books for the face amount of the bond. You remember the bond? We're thinking of it already written. It's already written basically in stone. You can think of it. You can't change it. The face amount of the bond is 240,000. So we're going to credit the fact that in 15 years we're going to owe credit. I'm going to represent credits with a negative in this worksheet, 240,000. All right. Now, obviously the debits do not equal the credits, meaning if I highlight both of these and look at the taskbar, we have a difference of 41516. We need another debit of that number. And therefore, I'm going to use our sum function, I call this the plug function, to sum up our journal entry and that's going to be the negative sum of these four cells, meaning it's going to take the 240 minus the 19844 and then flip the sign so it's a positive number. So there's the plug, meaning the debits now add up to 240, which ties out to the credit. If we highlight the debit and the credits, they add up to zero here on the taskbar. We are now in balance. However, what does that account go to? Where are we going to put that 41516? That's going to be what we're going to call a discount on the bonds. So we're going to have a discount on the bonds. Anytime we receive less cash than the bond face amount, then we're going to basically have a discount. And when you think about discounts, it's often easier to think of as if you're the purchaser. So if obviously you go to the store and you buy something for less than the sticker price, you can say that you got a discount, the purchaser got a discount. Obviously we are issuing the bond at a discount, but you can think of it the same way. The person buying the discount is buying the thing for less than the sticker price, which you can think of as basically a discount. If they pay more, it's going to be a premium. When will that happen? Well, it's going to happen. It's going to have to happen when the market rate is higher than the rate that's in stone on the bonds, not actually in stone, but you know, we're thinking about it can't change the market rate. And therefore it has to happen because in a free market, the people that are buying the bonds aren't going to buy a bond that's only paying 6% if they can go somewhere else and get 8% return on it. So that's when it's going to happen. We're going to have a discount when that happens. And therefore we're going to post this to the discount on the bonds. So note that the discount on the bonds is basically related to the bonds payable. So we're going to copy that. I'm going to copy the discount, copy that. We're going to put that in cell, C5, right click and paste it 1, 2, 3. Now note what I've done here is I've built this journal entry in a way that made sense to me in the most way and I don't have the two debits on top in this case. If you're putting this into a program that's going to be grading basically on whether the two debits are on top, you put the two debits on top. If you are working in a software where this was a way that helps you to build the journal entry and it would help you to audit it when you go back in and see what you did, then I would put it, I would abandon the debits on top principle if it helps you to have an accurate audit trail in terms of what you did. So then we can post this out. So we're going to post out the cash. Here's the cash. Here's the cash here. I'm going to post it to the adjusting area in I3. So in I3 we're going to say this equals 0.2 to 198, 484. This is a debit. This is a debit. It's going to make the debits go up in the debit direction 2, 918, 484. Then we're going to post the bonds payable, the liability bonds payable similar to a note. It's in the liability section here. We're going to post that to the adjusting column and see what happens. So we are in I6, we're going to say equals 0.2, that's 240, bringing the balance up to a credit of 240. Then we're going to have the discount on the bonds. Here's the discount. Here's the discount here. It's in the liability section. Again, I'm going to go to I7 equals and point to that 41516, bringing this balance up in the debit direction 2, of course, the 41516. Now note that this liability is kind of like a contra liability account. Why? Because it's a liability, but you can see it has a debit balance in it. So note that all other liabilities have credit balances. Why would this be in the liability section if it has a debit balance in it? And the reason is because it's basically related to the bond payable. So it's kind of part of the bond payable. We broke the bond payable out into these two sections. And what it really represents, the discount, remember it's the difference between these interest rates. We couldn't change the interest rate. We had to change the amount that we got paid. And therefore what that difference here is, you can kind of think of it as that's really the interest difference that we're going to have to account for throughout the life of the bond. In this problem, we're going to do that with the simplified method, which if it's not material to decision making would be the easiest method to use, which is just that we will then amortize this over a straight line method over the useful life 15 years and just bring this down to zero as we pay off the interest. What are we going to write it off to? Interest expense. So we're going to basically amortize this out to interest expense on a straight line method over the useful life over the life of the bonds in this case. So we're going to do that in the next part here. So with the next transaction, we're going to say in 630, we're going to record bond interest and straight line amortization. So remember, unlike like a mortgage, we're going to pay this every six months, half a year semi annually. That's one of the most common types of bonds that will be asked most of the time. So we're going to say on 630, we are going to pay this out. So first question, is cash affected? And yeah, cash is going to be affected because we are going to pay interest on the bonds semi annually and note how the bond again a little bit different than a mortgage in that we're paying off a bit of the interest as well as the principal. A bond is not in that format. And a lot of people when they think about loans, when they think about car payments and mortgage payments, it's easy for us to start thinking that that's the only format that a loan can take. And that's not the only form that, you know, a loan can take any kind of format. So we could pay just the interest for the loan and then pay the principal back at a lump sum. And that's basically the format that we are in here. So we're going to pay back solely interest and we're going to actually pay the interest and then pay back the principal of the 240 face amount at the end of the bond in this case. So that means that cash will be affected. Cash is going to go down because we're going to pay the interest. Interest only, no principal payment, unlike a mortgage type loan. And cash has a debit balance. We're going to make it go down by doing the opposite thing to it, which in this case would be a credit. So I'm going to copy the cash. I'm going to skip a line here. I'm going to skip a line because there's going to be two accounts on top. I'm going to try to put this in order in this case. So actually I'll skip one line. I'll put it right there. So we are in C8. We're going to right click and paste it one, two, three. All right. So so now we need to think about how much cash we're going to pay. And remember, if we take a look at what we have here, we have a 240,000 bond and we're going to multiply that times the rate and then think about the fact that we only have it. We're paying for half a year. Now the question is, of course, what rate do we multiply by? We multiply by the bond rate, the 6% rate, the rate on the bond. So remember, that's the part that's kind of set in stone. We're thinking we couldn't change that. We have to pay 6%. Even though the market rate was 8%. But we've already accounted for the 8% when we put the discount on there. Now we're going to pay off the rate that is on the note, the rate that's in the agreement. And that is going to be the 6%. So let's see that in a calculator first. Then we'll calculate it again in Excel. So we have the 240,000. We're going to multiply that times 6%. That's going to be 0.06 if we look at it in terms of a decimal. That means we have 14.6. I mean, 14.4. 14.4, that would be the interest. But remember, whenever we think about interest, we always basically think for a year. So even if you talk about home mortgage interest or something like that, which we pay monthly, it's when we say something like 5% is the rate, then we're usually talking about 5% for a year, which we would then have to break down to a monthly rate if we want to think about it in terms of a monthly rate. So this is how much we would pay for a year. But we're only going to pay it for six months because only six months have passed. And interest is similar to rent basically on a house.