FA 42 - Bonds issued at a Premium

Summary

In this educational video, the host explains the accounting treatment for bonds issued at a premium, using the example of Smokey Inc. issuing a $10 million bond with a 7% interest rate. The bond is issued at a premium due to a lower market rate of 6%, resulting in an actual issue price of $10.74 million. The video walks through the journal entries for bond issuance and the first two interest periods, including the amortization of the premium and the calculation of interest expense. It also covers the preparation of a bond amortization schedule, providing a clear understanding of the premium's impact on interest cost and carrying amount.

Takeaways

• 📘 The video discusses accounting for bonds issued at a premium, which is a continuation of the topic from previous videos on bonds issued at a discount.
• 📅 The example given is for Smokey Inc., which issues a $10 million, 10-year, 7% bond on April 30th, 2024.
• 🔢 The bond pays 7% annual interest, semi-annually at 3.5%, while the market rate of interest is 6%, leading to the bond being issued at a premium.
• 💰 The bond is issued at 107.439% of its face value, resulting in an extra $743,900 received over the $10 million face value.
• 📝 The initial journal entry records the receipt of cash and the bonds payable, with the premium being a credit that reduces the interest cost over the bond's life.
• 📊 A bond amortization schedule is prepared, detailing the interest payments, expenses, and premium amortization over the first two interest periods.
• 📈 The premium amortization reduces the premium balance and increases the bond carrying amount, reflecting the effective interest method.
• 📋 Journal entries are made for the bond issuance, the first interest payment, and adjusting entries at the fiscal year-end and the subsequent interest payment date.
• 🧮 The interest expense is calculated based on the carrying amount and the market rate, with premium amortization affecting the bond's carrying amount.
• 📉 The premium amortization results in a decrease in the premium balance, reflecting the bond's effective interest over time.
• 🔗 The video script suggests that understanding the discount side of bond accounting is helpful for grasping the premium side, and it encourages viewers to watch previous videos for a more detailed explanation.

Q & A

What is the main topic of the video script?

The main topic of the video script is accounting for bonds issued at a premium, including the process of recording journal entries and preparing a bond amortization schedule.

What is the significance of the bond premium?

The bond premium is the amount by which the bond is issued above its face value. It reduces the effective interest cost for the issuer because it's like receiving extra cash upfront, which is not required to be repaid at the end of the bond's term.

Why would a bond be issued at a premium?

A bond is issued at a premium when the market rate of interest is lower than the bond rate. Investors are willing to pay more than the face value for the bond because they are attracted by the higher interest rate offered by the bond.

What is the difference between the bond's maturity value and its carrying amount?

The maturity value is the face value of the bond, which is the amount that will be paid back to the bondholders at maturity. The carrying amount is the bond's accounting value on the company's balance sheet, which includes adjustments for any premium or discount and the amortization of these amounts over the life of the bond.

How is the interest expense calculated for the bond in the script?

The interest expense is calculated by applying the market rate of interest (6% annually, or 3% semi-annually) to the bond's carrying amount, which includes the initial premium and adjustments for premium amortization.

What is the process of bond amortization?

Bond amortization is the systematic allocation of the bond premium over the life of the bond. It involves reducing the premium balance and adjusting the bond's carrying amount to reflect the effective interest rate over time.

What is the purpose of recording journal entries for bond issuance and interest payments?

Recording journal entries for bond issuance and interest payments is essential for accurately reflecting the financial transactions in the company's accounting records. It helps in tracking the cash flows, interest expenses, and changes in the bond's carrying amount over time.

How does the script handle the semi-annual interest payments and their impact on the bond's carrying amount?

The script calculates the semi-annual interest payment based on the bond's maturity value and the interest rate. It then adjusts the interest expense and the bond's carrying amount by considering the premium amortization, which is the difference between the interest payment and the interest expense.

What is the role of the market rate of interest in the bond amortization schedule?

The market rate of interest is used to calculate the interest expense for the bond. It is a key factor in determining the amount of premium amortization, which affects the bond's carrying amount and the effective interest rate over the bond's life.

How does the script address the issue of rounding errors in the calculations?

The script acknowledges the rounding errors that occur during the calculations and explains that they are not significant for the overall understanding of the process. It also suggests that exact precision can be achieved by avoiding rounding during calculations.

What advice does the script give for those who are new to the topic of bond accounting?

The script advises those who are new to bond accounting to start with the basics, such as understanding the process of bonds issued at a discount (as covered in a previous video), before moving on to bonds issued at a premium.

Outlines

00:00

📘 Introduction to Bond Accounting and Workbook

The video script introduces viewers to a problem available for download on a 'Counting workbook calm' website. It guides users on how to access a PDF and video resources covering various problems, including public and members-only videos on YouTube. The speaker then dives into problem 9, which involves accounting for bonds issued at a premium, contrasting with bonds issued at a discount. The example provided is about Smokey Inc. issuing a $10 million, 10-year, 7% bond on April 30, 2024, with a market interest rate of 6%. The bond is issued at a premium due to the higher interest rate offered, resulting in an issuance at 107.439% of the face value, totaling $10,743,900. The script suggests that viewers should have prior knowledge of bonds and recommends starting with a previous video for a deeper understanding.

05:02

📊 Bond Issuance and Amortization Schedule

This paragraph explains the process of issuing bonds and creating an amortization schedule. The script details the first journal entry for the bond issuance on April 30, 2024, where Smokey Inc. receives cash exceeding the face value due to the premium. It then outlines the creation of a bond amortization schedule, starting from the issuance date through the first two interest periods. The schedule includes columns for interest payment, market rate, discount amortization, and adjustments to the bond carrying amount and premium account balance. The example provided calculates the interest expense and premium amortization for the periods ending October 31, 2024, and April 30, 2025, adjusting the bond carrying amount accordingly.

10:04

📝 Journal Entries for Bond Transactions

The script continues with the explanation of journal entries related to bond transactions. It covers the entry for the first interest payment on October 31, 2024, which includes a credit to cash and a debit to interest expense, as well as the amortization of the bond premium. The discussion then shifts to the fiscal year-end on December 31, 2024, where the script calculates the interest expense and premium amortization for the two months between October 31 and December 31. The journal entry for this period includes adjusting the interest payable and recording the accrued interest expense, with a note on the rounding discrepancies that may occur due to the calculations.

15:06

🔚 Conclusion and Final Journal Entry for Problem 9

The final paragraph wraps up the problem by addressing the journal entry for April 30, 2025, which includes the payment of interest and the recording of the interest expense for the period between December 31 and April 30. The script acknowledges the rounding issues and emphasizes that such discrepancies are negligible in the context of the overall problem. It concludes by encouraging viewers to like the video if they found it useful and bids them farewell until the next video.

Keywords

💡Bonds

Bonds are debt securities issued by entities such as corporations or governments to raise capital. In the video, the theme revolves around accounting for bonds, specifically those issued at a premium. Bonds are a form of loan where the bondholder is the lender, and the issuing company is the borrower. The script discusses how bonds are issued at a premium when the market interest rate is lower than the bond's interest rate, leading to investors paying more than the face value for the bond.

💡Discount

A discount in the context of bonds refers to the situation where the bond is issued at a price lower than its face value. Although the video primarily discusses premium bonds, the concept of discount is introduced as a comparison. The script mentions bonds issued at a discount as a contrasting scenario to bonds issued at a premium, emphasizing the difference in accounting treatment.

💡Premium

A bond premium is the amount by which the issue price of a bond exceeds its face value. The video script explains that Smokey Inc. issues bonds at a premium because the bond's interest rate is higher than the market rate, making it attractive for investors to pay more upfront. The premium is then amortized over the life of the bond, affecting the interest expense calculation.

💡Market Rate

The market rate of interest is the current rate of interest for a bond of similar risk and maturity in the market. In the script, it is highlighted that the market rate is 6%, which is lower than the bond rate of 7% offered by Smokey Inc., resulting in the bond being issued at a premium.

💡Interest Expense

Interest expense is the cost of borrowing represented as the interest paid on debt. In the video, the script explains how the interest expense is calculated at the market rate of 6% semi-annually, which is used to determine the premium amortization and the carrying amount of the bond.

💡Amortization

Amortization refers to the process of gradually writing off the premium or discount of a bond over its life. The script details the amortization schedule for the bond premium, showing how the premium is reduced over time as the bond approaches its maturity value.

💡Bond Carrying Amount

The bond carrying amount is the net book value of a bond after accounting for any premium or discount and its amortization. The script provides calculations for the bond carrying amount, starting with the face value plus the premium and adjusting it with the amortized premium over each interest period.

💡Journal Entry

A journal entry in accounting is a record of a transaction that affects at least two accounts. The video script includes journal entries for the issuance of the bond and the subsequent interest payments and premium amortization, illustrating the accounting treatment of bonds issued at a premium.

💡Semi-Annual

Semi-annual refers to something that occurs twice a year or every six months. In the context of the script, the bond pays interest semi-annually, and the amortization of the premium is also calculated on a semi-annual basis, as shown in the bond amortization schedule.

💡Fiscal Year

A fiscal year is the period used by a business for accounting purposes, which may differ from the calendar year. The script mentions the company's fiscal year-end as December 31st, indicating the time when the company closes its financial accounts and prepares financial statements.

💡Interest Payable

Interest payable is a liability account that represents the amount of interest owed but not yet paid. In the script, the concept is used to explain the accounting for the accrual of interest expense over the period leading up to the payment date, particularly in relation to the company's fiscal year-end.

Highlights

Introduction to accounting for bonds issued at premiums, which is a continuation from bonds issued at discounts.

Explanation of bond issuance by Smokey Inc. on April 30th, 2024, with a $10 million 10-year 7% bond.

Clarification that the bond pays 7% annual interest, semi-annually at 3.5%.

Market rate of interest is 6%, which is lower than the bond rate, leading to a premium issuance.

Bonds are issued at a premium of 107.439%, resulting in an extra $743,900 over the face value.

The premium is considered an interest cost reduction, akin to interest revenue.

Journal entry for the bond issuance on April 30th, 2024, including the cash received and bonds payable.

Introduction of the bond amortization schedule for the first two interest periods.

Explanation of the interest payment on October 31st, 2024, and the corresponding journal entry.

Calculation of interest expense and premium amortization for the period between October 31st and April 30th, 2025.

Journal entry for the first interest payment, including the debit to interest expense and the amortization of the premium.

Discussion of the fiscal year-end adjustments for December 31st, 2024, including interest expense and premium amortization.

Journal entry for December 31st, 2024, reflecting the accrual of interest and the adjustment of the premium.

Final journal entry for April 30th, 2025, detailing the payment of interest and the closing of the interest payable.

Emphasis on the importance of understanding the discount side of bonds before tackling the premium side.

Recommendation to watch previous videos for a more detailed explanation of the steps involved.

Note on the rounding issues during calculations and the impact on the final journal entries.

Encouragement for viewers to like the video if they found it useful, enhancing engagement.

Transcripts

the problem from this video can be

downloaded at a Counting workbook calm

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link and you can download a copy of this

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has either a public video or a

members-only video if you'd like access

to the members only video just click the

join button beneath the video player on

YouTube alright let's jump into the

problem let's examine problem 9 for a

we've just been doing a couple of bonds

issued at discounts now we're gonna look

at accounting for bonds issued at

premiums if you've understood the

discount side the premium side isn't

much of a stretch but if you haven't

understand that stood the discount side

very well well this is your second crack

at bonds and maybe the premium side will

help bring things into focus on April

30th 2024 smokey inc issues a 10 million

dollar 10 year 7% bond so we're giving

7% annual interest three and a half

percent semi-annually that's our

interest that we're giving to our bond

purchases the people loaning us money

we're gonna pay them back 7% the market

rate of interest is 6% so KX similar

companies to us are offering 6% in the

market our risk profile kind of warrants

6% we're offering 7% people are gonna

really love our bond and they're gonna

want to pay and in fact overpay for

everyone they're gonna pay more than

face value for our bond our bond is

going to issue at a premium because the

market rate is lower than the bond rate

the bonds issue at a premium the mon

quote is 107 point 4 3 9 remember what

that number is that is the the quote but

it's also a percentage 107 point 4 3 9

percent that's how much we're gonna

charge 107 percent of what we were

asking so we wanted 10 million well

guess what we're getting 10 point 7

million

we're getting over 700,000 extra dollars

because we're paying more in interest

over time now we've got enough

information to do our first journal

entry April 30th 2024 now I'm just

dawning on me as I work on this if

you're just coming to this going I want

to start on 940 make sure you watch the

video for 938 I really will spend a lot

more time there explaining each step

this kind of assumes a little bit of

background knowledge it assumes you've

tried 9 3a already so if you're just

jumping into this don't start here start

with 93 and then move over to 9 for 8

but anyway let's let's continue so on

April 30th what happens well again what

is a bond we're borrowing money we're

giving a bunch of pieces of paper out

saying I owe you this much I owe you

that much in this to hundreds of

potential lenders all at once we're

getting cash though and how much money

are we getting we're getting more than

we asked for we asked for 10 million

we're getting ten point seven ten seven

four three nine hundred now what am I

giving up well I'm giving up pieces of

paper saying I promise to pay back bonds

payable 10 million and what's the

difference here it's the premium now

it's a missing credit of 743 900 they

paid 743 900 above asking for these

bonds they paid a premium now what is a

premium do well we're paying high

interest through the bond or paying 7%

when the market rate was 6% the premium

reduces that interest cost because it's

almost like interest revenue you can

think of that as an extra 70 for like

extra cash of 743 thousand that I don't

have to pay back at the end of the bond

that's almost like an interest premium

right it's extra interest it's good

interest for me not interest expense but

having said that to get that extra

interest it means I've got to pay it out

over the life of the bond okay so we've

done record the journal entry for the

issuance of the bond now we got to do

this

prepare a bond amortization schedule for

the issuance in the first actually it's

only the first two interest periods so

let's do the issuance of our bond on

April 30th 2024 now on the issue date I

don't have an interest payment I don't

have an interest expense I don't have a

discount or a premium to amortize I do

have a premium account balance of seven

four three nine hundred and I do have a

bond carrying amount now if I had to

discount blank - the because I have a

premium it's 10 million plus D so 10

million plus whatever is indeed d is

seven four three nine hundred so it's

ten million seven four three nine

hundred I should have dealt with these

these headings as well

ABC let's take a look

interest payment blank percent of

maturity value well this is what we are

promising to pay and our rate is seven

percent now again because everything's

semi-annual here we got to divide that

by 2 we get 3 and 1/2 percent it's 7%

per year

three and a half percent every six

months in this table is a semi-annual

table it's in every six month table so

that's why we have that number the

market rate is what's relevant for our

interest expense our market rate was 6%

again divided by two that gives us three

percent is the percentage we're going to

use for this column discount

amortization well we don't have a

discount we have a premium discount

account mouths no premium account

balance then we've done the bond

carrying them okay so that's April

thirtieth twenty twenty four our first

interest payment happened six months

later on October 31st so again May June

July August September October yep that's

six months what's happening on October

31st 2024 we make an interest payment we

pay three and a half percent of our

maturity value so 0.03 five times the

maturity value which was ten million

dollars we pay three hundred fifty

thousand dollars in interest on this day

the interest expense is

3% of the carrying amount 3%

10 743 900 these are carrying amount

just call them either' wheat a3 or the

interest expense is 3% of its so times

0.03 3 2 2 3 1 7 now this time premium

amortization is a minus B might ever

remember discount amortization was B

minus a premium is the opposite a minus

B so 350 - 322 3 500 - 3 2 - 3 1 7 is 27

683 premium account balance D - C 743

900 - 27 683 is 7 1 6 - 1 7 and our bond

carrying about 10 million plus whatever

them call them D so 10 7 1 6 - 1 7 okay

so that's October 31st the next interest

payment is April 30th 6 months later so

November December January February March

April so yeah that's right April 30th

2025 we make a payment now again the

interest payment is three and a half

percent of maturity value our maturity

value is still 10 million bucks so it's

still 350 and unless there's some sort

of bond redemption or something going on

here we expect this to be the same every

six months that's the idea of bonds it's

like steady Eddie they call them fixed

income for the investor their fixed

income for the borrower for the company

they're like a fixed expense it's the

same every six months or a fixed cash

outlay I guess I should say okay the

interest expense here 3% of the

preceding bond carrying amount point O

three times the preceding bond carrying

amount which was ten seven one six two

one

oops two

one seven three percent of that three

two one four eight we're going to round

here three two one four eight seven our

premium amortization a minus B so 350 -

three two one four eight seven twenty

eight five one three premium compounds D

- C seven one six two one seven minus

twenty eight five one three six eight

seven seven five eight and last ten

million plus whatever's in column D ten

six eight seven seven five eight okay

there we have it my pens on the fritz

again so I hope it's reasonably legible

okay so we've done the bond amortization

schedule now we've got to do journal

entries we did the issuance of the bond

onto the first interest payment for the

first interest payment it's just this

line this six-month period is covered by

our first interest payment between April

30th the issuance and October 31st let's

see what's happening we make a payment

of 350 so credit cash of course 350

credit cash 350 the debit to interest

expense is 320 to 317 320 to 317 the

premium amortization we reduce our

premium our premium when we set it up as

a credit to reduce it it takes of course

a debit debit premium 27 683 and there

we have it October 31st 2024 our next

relevant date is not April 30th is the

item indicates it's our company's fiscal

year in which is December 31st so what

do we have October so November December

two months right between October 31st in

our fiscal yen well let's think about

this

this line noted by April 30th represents

the time period between October 31st and

April 30th it represents let's see

October 3 or so November let me just

minimize this December January February

March and April to get us up to April

30th now we're interested our fiscal

year-end happens here we're interested

in December 31st so we're interested in

these two months out of a total of six

we're interested in 2/6

of whatever is going on here so for

instance we're interested in this

interest expense but because it's only

two months we're interested in 2/6 of

that interest expense 3 2 1 4 8 7 times

2 divided by 6

107 162 is our interest expense for our

fiscal year and December 31st

that amount again was 107 one six to our

premium amortization which just takes a

debit is 28 five one three again times

two 695 oh for now our credit would

normally be the cash but we're not

paying any cash today we pay cash every

six months the people that have invested

in us the people that have bought our

bonds aren't expecting a cash payment

today and they're not going to get one

but the amount 350 times to sixth is

very relevant it's the amount of

interest that is built up one one six

six six six seven I can see I've got a

rounding problem here one one six six

six seven I've rounded and you can see

two plus four it's not going to equal

exactly but it's no big deal if I had

rounded not rounded at all this would've

worked out perfectly I'm gonna leave

this as is if you're off by a dollar in

my class no big deal your prof might

want you to go to the decimals but

that's their prerogative

so normally here we would credit cash

we're gonna credit interest payable and

I just wanted to show my debits don't

quite equal my credits 107 162 is my

debit plus 95 old for debit gives me one

one six six six six six I have one one

six six six six seven and it's just a

rounding thing going on okay so I was

December 31st 2024 that's going to bring

us to our final entry April 30th 20 25

what happens on April 30th 20 25 well we

make our payment right we make a payment

so I credit cash how much do I pay I pay

the full amount I don't pay for six

there's some smaller amount I pay 350 on

April 30 so credit cash 350 any interest

payable needs to go away so I'm gonna

debit interest payable

one one six six six seven I also need to

get rid of or not get rid of record the

interest now how much interest expense

has built up well

we dealt with the two six up to December

31st now we're dealing with the period

between December and April how many

months is that January February March

April that's the other four six that's

the other four months that's these four

months January February March April

so hopefully to the surprise of no one

that's four six so I just for my

interest expense it's going to be four

six of that number and for my premium

amortization four sixths of that one so

let's do it

three two one four eight seven times

four divided by 6 2 1 4 3 2 5 2 1 4 3 2

5 that's my interest expense 2 1 4 3 2 5

and my premium amortization and that is

2 8 5 1 3 times 4 divided by 6 1 900 9

now hopefully this adds up let's just

see 2 1 4 again I think I'm off by $1 3

to 5 plus 1 900 9 + 1 1 6 6 6 7 3 500 1

and again it's it doesn't match because

it's off by a buck because of rounding

issues no big deal for me if I had made

this a 6 and this one a 6 it would have

worked out perfectly but again it's just

cuz pennies which when we're doing this

with our computers it's they're knocking

around in the same way okay we've done

it we have solved problem 9 for a if you

found this video useful and I hope you

have you're here at the end I do hope

you'll consider hitting the old like

button alright thanks a lot

everybody have a great day and I'll talk

to you soon bye for now