Professor Hawley: So, um, let's go ahead, we'll just work on this together.
Um, it says, presented below are two independent situations.
So, George Gershwin Company sold $2,000,000 of 10%, 10-year bonds at 104
on January 1st of '25.
The bonds were dated January 1st of '25.
Okay, that was probably a repeat.
And, pay interest on July 1st and January 1st.
If Gershwin uses the straight line method to amortize bond premium or discount,
determine the amount of interest expense to be reported on July 1st '25 and
December 31st of '25.
Alright, well what I would like to do is start with the entry that would have been
recorded when they issued the bond, just so that we can kind of get that on
paper so we can see it.
So, we have-- the bonds were issued.
This would be-- the $2 million would be the face value.
And, 10% would be, what?
The stated rate, okay.
It's a 10-year bond.
It was issued at 104, so that means that it was issued at a premium.
They're dated January 1st and they pay interest twice per year, so how many
interest payment periods would there be in this bond?
20, right, 'cause it's 10 years, they pay interest twice per year.
So, because they are using the straight line method, we would say there is
20 interest payment periods.
Okay, so on 1/1 when they issue the bonds, how much cash would they receive?
Debit cash for the face value of $2 million times 1.04.
And that would be a cash receipt of $2,080,000.
And then, how much did they need to pay back at the end?
They're going to credit bonds payable for always the face value, right?
$2 million.
Alright, and we clearly said this was issued at a premium, so we know
just by looking at this, to balance our entry, we're going to have to credit
$80,000 credit to premium on bonds-- I'll just put BP-- bonds payable.
So, if you get confused ever on what is the premium or is it a premium or a
discount, look at your journal entry and see where it needs to go.
It needs to be a credit or a debit.
So, in this case, it needs to be a credit, and we know that a premium on
bonds payable has a normal credit balance.
It's an adjunct account, meaning it comes alongside the bond payable, it actually
increases the bond payable.
Where as, the discount on bonds payable is a contra-account.
It is the opposite, so it's a debit.
Normal debit balance, and it's going to subtract, or it's going to reduce that bond payable.
Okay, so, the premium is $80,000 and we determined that we're going to divide that
by 20, that's the number of interest payment periods.
And that would be $4,000 per interest payment period.
Okay, so we're-- the question is asking us to determine the interest expense
to reported on July 1 and December 31st.
So, let's just do it in the form of a journal entry.
So on July 1 of '25, how much, um-- the question is, in this case, if we're
doing the straight line amortization, we know that we're going to debit
interest expense, but with straight line amortization, the interest expense is
the plug number, okay?
We are going to credit cash because we're actually paying interest out,
and at what rate are we paying interest out?
So, 10% for 6 out of 12 months, right?
So, it's at the stated rate.
So we say, the face value of $2 million times the stated rate of 10 % times
the time, which is 6 out of 12 months.
Which would be the same thing as saying 5%, right?
Um, so the cash being paid out, if we do the math there, cash being paid out is $100,000.
And, we need to amortize that discount-- sorry, excuse me, premium.
And we determined that each interest period we're going to amortize the
premium by $4,000.
Now, remember, the premium has a credit balance, so to amortize it, I need to
debit it.
So, I'm going to debit premium on bonds payable $4,000.
And then, the difference between what we paid in cash and the premium that we
amortized is going to be our interest expense.
So, $96,000.
So, you can also think of it as when you issue bonds at a discount, the interest
expense-- sorry, premium-- the interest expense per period is reduced.
Why? Because you received more cash up front, so the amount that you're--
you're paying interest on a smaller face value, but you received more cash,.
So, it's effectively reducing your interest rate because you received
more cash up front.
And then on 12/31, the entry would be similar.
We're going to debit interest expense.
We're going to debit premium on bonds payable.
And that's going to be at that same straight line rate, so that's $4,000.
And then, we're going to credit-- and this one is payable on January 1st.
So, we're going to credit interest payable $100,000.
And again, the interest expense i going to remain the same at $96,000.
Alright, let's do part B then.
Um, Ron Kenoly Inc. issued $600,000 9%, 10-year bonds on June 30th of '25
for $562,500.
This price provides a yield of 10%.
Okay, so we have 2 different interest rates.
9% is, what?
9% is the stated rate, and 10% is the market rate,
or the effective rate.
Interest is payable semiannually on December 31st and June 30th.
If Kenoly uses the effective interest method, determine the amount of
interest expense to record if financial statements are issued on October 31st of '25.
So, this one's a little more-- it's got a little more different things going on here.
So, not only are we using the effective method, but we are also only calculating
interest expense through October 31st.
Okay, so first, again, let's go ahead and record the issuance of the bonds.
They issued the bonds on 6/30, and they're going to debit cash.
They said they received-- they told us how much they received-- $562,500.
And, we're going to record a credit to bonds payable always for the face value,
which is $600,000.
Which means they recorded those bonds at a discount.
And so, we're going to debit discount on bonds payable for $37,500.
That's going to balance our entry, right?
Alright, now, assuming that we are going to issue financial statements on September 31st,
what do we need to do?
We need to make sure that those financial statements are up to date with regard to
interest expense and interest payable.
How much do we owe at that time?
So, on 10/31/25, we're going to