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.