1
00:00:00,001 --> 00:00:05,914
Professor Hawley: So, um, let's go ahead,
we'll just work on this together.

2
00:00:05,914 --> 00:00:12,861
Um, it says, presented below are two
independent situations.

3
00:00:12,861 --> 00:00:20,676
So, George Gershwin Company sold 
$2,000,000 of 10%, 10-year bonds at 104

4
00:00:20,676 --> 00:00:24,009
on January 1st of '25.

5
00:00:24,009 --> 00:00:27,507
The bonds were dated January 1st of '25.

6
00:00:27,507 --> 00:00:29,808
Okay, that was probably a repeat.

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00:00:29,808 --> 00:00:34,039
And, pay interest on July 1st and 
January 1st.

8
00:00:34,039 --> 00:00:39,572
If Gershwin uses the straight line method
to amortize bond premium or discount,

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determine the amount of interest expense
to be reported on July 1st '25 and

10
00:00:44,938 --> 00:00:49,137
December 31st of '25.

11
00:00:49,137 --> 00:00:53,787
Alright, well what I would like to do is
start with the entry that would have been

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recorded when they issued the bond, 
just so that we can kind of get that on

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paper so we can see it.

14
00:01:01,418 --> 00:01:04,784
So, we have-- the bonds were issued.

15
00:01:04,784 --> 00:01:09,015
This would be-- the $2 million would be
the face value.

16
00:01:09,015 --> 00:01:13,381
And, 10% would be, what?

17
00:01:13,381 --> 00:01:16,297
The stated rate, okay.

18
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It's a 10-year bond.

19
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It was issued at 104, so that means that
it was issued at a premium.

20
00:01:25,045 --> 00:01:29,560
They're dated January 1st and they pay
interest twice per year, so how many

21
00:01:29,560 --> 00:01:36,858
interest payment periods would 
there be in this bond?

22
00:01:36,858 --> 00:01:40,358
20, right, 'cause it's 10 years, they pay
interest twice per year.

23
00:01:40,358 --> 00:01:45,156
So, because they are using the straight
line method, we would say there is

24
00:01:45,156 --> 00:01:55,086
20 interest payment periods.

25
00:01:55,086 --> 00:02:00,886
Okay, so on 1/1 when they issue the bonds,
how much cash would they receive?

26
00:02:00,886 --> 00:02:08,051
Debit cash for the face value of 
$2 million times 1.04.

27
00:02:08,051 --> 00:02:16,430
And that would be a cash receipt
of $2,080,000.

28
00:02:16,430 --> 00:02:20,795
And then, how much did they need to pay
back at the end?

29
00:02:20,795 --> 00:02:32,741
They're going to credit bonds payable 
for always the face value, right?

30
00:02:32,741 --> 00:02:34,658
$2 million.

31
00:02:34,658 --> 00:02:39,839
Alright, and we clearly said this was
issued at a premium, so we know

32
00:02:39,839 --> 00:02:42,938
just by looking at this, to balance our
entry, we're going to have to credit

33
00:02:42,938 --> 00:02:53,169
$80,000 credit to premium on bonds--
I'll just put BP-- bonds payable.

34
00:02:53,169 --> 00:02:59,652
So, if you get confused ever on what is 
the premium or is it a premium or a

35
00:02:59,652 --> 00:03:03,517
discount, look at your journal entry and
see where it needs to go.

36
00:03:03,517 --> 00:03:05,517
It needs to be a credit or a debit.

37
00:03:05,517 --> 00:03:08,216
So, in this case, it needs to be a credit,
and we know that a premium on

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bonds payable has a normal credit balance.

39
00:03:10,897 --> 00:03:15,648
It's an adjunct account, meaning it comes
alongside the bond payable, it actually

40
00:03:15,648 --> 00:03:17,848
increases the bond payable.

41
00:03:17,848 --> 00:03:22,396
Where as, the discount on bonds payable
is a contra-account.

42
00:03:22,396 --> 00:03:25,728
It is the opposite, so it's a debit.

43
00:03:25,728 --> 00:03:30,762
Normal debit balance, and it's going to
subtract, or it's going to reduce that bond payable.

44
00:03:30,762 --> 00:03:37,093
Okay, so, the premium is $80,000 and we
determined that we're going to divide that

45
00:03:37,093 --> 00:03:41,325
by 20, that's the number of interest 
payment periods.

46
00:03:41,325 --> 00:03:51,689
And that would be $4,000 per 
interest payment period.

47
00:03:51,689 --> 00:03:56,955
Okay, so we're-- the question is asking
us to determine the interest expense

48
00:03:56,955 --> 00:04:00,132
to be reported on July 1 and
December 31st.

49
00:04:00,132 --> 00:04:02,530
So, let's just do it in the form of a 
journal entry.

50
00:04:02,530 --> 00:04:09,547
So on July 1 of '25, how much, um--
the question is, in this case, if we're

51
00:04:09,547 --> 00:04:14,446
doing the straight line amortization,
we know that we're going to debit

52
00:04:14,446 --> 00:04:20,826
interest expense, but with straight line
amortization, the interest expense is

53
00:04:20,826 --> 00:04:23,491
the plug number, okay?

54
00:04:23,491 --> 00:04:29,342
We are going to credit cash because
we're actually paying interest out,

55
00:04:29,342 --> 00:04:32,690
and at what rate are we paying 
interest out?

56
00:04:32,690 --> 00:04:36,106
So, 10% for 6 out of 12 months, right?

57
00:04:36,106 --> 00:04:38,739
So, it's at the stated rate.

58
00:04:38,739 --> 00:04:44,837
So we say, the face value of $2 million 
times the stated rate of 10 % times

59
00:04:44,837 --> 00:04:49,402
the time, which is 6 out of 12 months.

60
00:04:49,402 --> 00:04:52,651
Which would be the same thing as
saying 5%, right?

61
00:04:52,651 --> 00:05:02,650
Um, so the cash being paid out, if we do
the math there, cash being paid out is $100,000.

62
00:05:02,650 --> 00:05:07,581
And, we need to amortize that discount--
sorry, excuse me, premium.

63
00:05:07,581 --> 00:05:11,464
And we determined that each interest
period we're going to amortize the

64
00:05:11,464 --> 00:05:13,495
premium by $4,000.

65
00:05:13,495 --> 00:05:17,913
Now, remember, the premium has a credit
balance, so to amortize it, I need to

66
00:05:17,913 --> 00:05:19,347
debit it.

67
00:05:19,347 --> 00:05:27,510
So, I'm going to debit premium on
bonds payable $4,000.

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00:05:27,510 --> 00:05:32,226
And then, the difference between what we 
paid in cash and the premium that we

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00:05:32,226 --> 00:05:35,325
amortized is going to be our
interest expense.

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00:05:35,325 --> 00:05:37,825
So, $96,000.

71
00:05:37,825 --> 00:05:44,906
So, you can also think of it as when you 
issue bonds at a discount, the interest

72
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expense-- sorry, premium-- the interest
expense per period is reduced.

73
00:05:50,672 --> 00:05:55,244
Why? Because you received more
cash up front, so the amount that you're--

74
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you're paying interest on a smaller face
value, but you received more cash.

75
00:06:00,526 --> 00:06:04,190
So, it's effectively reducing your 
interest rate because you received

76
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more cash up front.

77
00:06:06,557 --> 00:06:11,406
And then on 12/31, the entry 
would be similar.

78
00:06:11,406 --> 00:06:16,104
We're going to debit interest expense.

79
00:06:16,104 --> 00:06:21,237
We're going to debit premium on 
bonds payable.

80
00:06:21,237 --> 00:06:25,269
And that's going to be at that same 
straight line rate, so that's $4,000.

81
00:06:25,269 --> 00:06:29,752
And then, we're going to credit-- and
this one is payable on January 1st.

82
00:06:29,752 --> 00:06:42,815
So, we're going to credit interest payable
$100,000.

83
00:06:42,815 --> 00:06:48,295
And again, the interest expense
is going to remain the same at $96,000.

84
00:06:48,295 --> 00:06:51,528
Alright, let's do part B then.

85
00:06:51,528 --> 00:06:59,326
Um, Ron Kenoly Inc. issued $600,000
9%, 10-year bonds on June 30th of '25

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00:06:59,326 --> 00:07:02,908
for $562,500.

87
00:07:02,908 --> 00:07:07,622
This price provides a yield of 10%.

88
00:07:07,622 --> 00:07:10,241
Okay, so we have 2 different interest rates.

89
00:07:10,241 --> 00:07:12,006
9% is, what?

90
00:07:12,006 --> 00:07:17,187
9% is the stated rate,
and 10% is the market rate,

91
00:07:17,187 --> 00:07:19,055
or the effective rate.

92
00:07:19,055 --> 00:07:25,587
Interest is payable semiannually
on December 31st and June 30th.

93
00:07:25,587 --> 00:07:30,068
If Kenoly uses the effective interest 
method, determine the amount of

94
00:07:30,068 --> 00:07:36,783
interest expense to record if financial
statements are issued on October 31st of '25.

95
00:07:36,783 --> 00:07:40,649
So, this one's a little more-- it's got a
little more different things going on here.

96
00:07:40,649 --> 00:07:45,731
So, not only are we using the effective 
method, but we are also only calculating

97
00:07:45,731 --> 00:07:49,414
interest expense through October 31st.

98
00:07:49,414 --> 00:07:55,478
Okay, so first, again, let's go ahead and
record the issuance of the bonds.

99
00:07:55,478 --> 00:08:03,593
They issued the bonds on 6/30,
and they're going to debit cash.

100
00:08:03,593 --> 00:08:11,259
They said they received-- they told us
how much they received-- $562,500.

101
00:08:11,259 --> 00:08:16,758
And, we're going to record a credit to
bonds payable always for the face value,

102
00:08:16,758 --> 00:08:19,091
which is $600,000.

103
00:08:19,091 --> 00:08:25,206
Which means they recorded those bonds
at a discount.

104
00:08:25,206 --> 00:08:34,888
And so, we're going to debit discount on
bonds payable for $37,500.

105
00:08:34,888 --> 00:08:37,203
That's going to balance our entry, right?

106
00:08:37,203 --> 00:08:43,985
Alright, now, assuming that we are going
to issue financial statements on September 31st,

107
00:08:43,985 --> 00:08:46,068
what do we need to do?

108
00:08:46,068 --> 00:08:49,133
We need to make sure that those financial
statements are up to date with regard to

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00:08:49,133 --> 00:08:53,982
interest expense and interest payable.

110
00:08:53,982 --> 00:08:56,682
How much do we owe at that time?

111
00:08:56,682 --> 00:09:07,844
So, on 10/31/25, we're going to debit 
interest expense.

112
00:09:07,844 --> 00:09:12,027
And, how much interest expense
would there have been?

113
00:09:12,027 --> 00:09:16,276
How do we calculate using the effective
method--the effective interest method?

114
00:09:16,276 --> 00:09:20,359
Well, if we look-- if we net together the 
discount and the bonds payable,

115
00:09:20,359 --> 00:09:30,208
we'll see that the carrying value of the
loan is $562,500 as of 6/30.

116
00:09:30,208 --> 00:09:35,939
So, when we say that's our debt
outstanding from 6/30 to 12-- excuse me,

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00:09:35,939 --> 00:09:38,487
to October 31st.

118
00:09:38,487 --> 00:09:43,305
So, all of July, August, September, 
October, so 4 months, um, interest

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has been accruing.

120
00:09:45,353 --> 00:09:48,935
So if we take this to calculate our 
interest expense using the effective rate,

121
00:09:48,935 --> 00:09:53,518
we're going to say times the effective
rate of 10%, or the yield rate.

122
00:09:53,518 --> 00:09:59,633
But then also, times 4 out of 12 because 
it's only 4 months that has passed by.

123
00:09:59,633 --> 00:10:08,848
So, we're going to debit interest expense
by $562,500 times 10% times 4/12.

124
00:10:08,848 --> 00:10:15,445
That would be $18,750, okay.

125
00:10:15,445 --> 00:10:23,312
And then, we're going to credit interest
payable, and this is going to represent, what?

126
00:10:23,312 --> 00:10:27,477
How much cash we have due at this moment.

127
00:10:27,477 --> 00:10:30,226
And so, how do you think we would
calculate the interest payable?

128
00:10:36,607 --> 00:10:40,874
So for interest payable, it's just the
cash that we would pay if we had to pay

129
00:10:40,874 --> 00:10:49,137
right now would be the face value times 
the stated rate times time.

130
00:10:49,137 --> 00:10:54,971
So in this case, the face value is
$600,000 times the stated rate, which

131
00:10:54,971 --> 00:10:59,769
is 9%, times 4 out of 12.

132
00:10:59,769 --> 00:11:07,902
And so, if we do the math there, that's
$18,000.

133
00:11:07,902 --> 00:11:13,982
Now remember, when we use the effective
interest method, what is the plug?

134
00:11:13,982 --> 00:11:17,814
The plug number is the discount or 
premium amortization.

135
00:11:17,814 --> 00:11:21,964
So, here we have a discount, we're 
amortizing it, so we're going to credit it

136
00:11:21,964 --> 00:11:28,164
to make it smaller-- discount on bonds
payable, the difference is going to be

137
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$750, so that's going to be
our amortization, okay.