WEBVTT 00:00:00.001 --> 00:00:05.914 Professor Hawley: So, um, let's go ahead, we'll just work on this together. 00:00:05.914 --> 00:00:12.861 Um, it says, presented below are two independent situations. 00:00:12.861 --> 00:00:20.676 So, George Gershwin Company sold $2,000,000 of 10%, 10-year bonds at 104 00:00:20.676 --> 00:00:24.009 on January 1st of '25. 00:00:24.009 --> 00:00:27.507 The bonds were dated January 1st of '25. 00:00:27.507 --> 00:00:29.808 Okay, that was probably a repeat. 00:00:29.808 --> 00:00:34.039 And, pay interest on July 1st and January 1st. 00:00:34.039 --> 00:00:39.572 If Gershwin uses the straight line method to amortize bond premium or discount, 00:00:39.572 --> 00:00:44.938 determine the amount of interest expense to be reported on July 1st '25 and 00:00:44.938 --> 00:00:49.137 December 31st of '25. 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 00:00:53.787 --> 00:00:59.334 recorded when they issued the bond, just so that we can kind of get that on 00:00:59.334 --> 00:01:01.418 paper so we can see it. 00:01:01.418 --> 00:01:04.784 So, we have-- the bonds were issued. 00:01:04.784 --> 00:01:09.015 This would be-- the $2 million would be the face value. 00:01:09.015 --> 00:01:13.381 And, 10% would be, what? 00:01:13.381 --> 00:01:16.297 The stated rate, okay. 00:01:16.297 --> 00:01:19.146 It's a 10-year bond. 00:01:19.146 --> 00:01:25.045 It was issued at 104, so that means that it was issued at a premium. 00:01:25.045 --> 00:01:29.560 They're dated January 1st and they pay interest twice per year, so how many 00:01:29.560 --> 00:01:36.858 interest payment periods would there be in this bond? 00:01:36.858 --> 00:01:40.358 20, right, 'cause it's 10 years, they pay interest twice per year. 00:01:40.358 --> 00:01:45.156 So, because they are using the straight line method, we would say there is 00:01:45.156 --> 00:01:55.086 20 interest payment periods. 00:01:55.086 --> 00:02:00.886 Okay, so on 1/1 when they issue the bonds, how much cash would they receive? 00:02:00.886 --> 00:02:08.051 Debit cash for the face value of $2 million times 1.04. 00:02:08.051 --> 00:02:16.430 And that would be a cash receipt of $2,080,000. 00:02:16.430 --> 00:02:20.795 And then, how much did they need to pay back at the end? 00:02:20.795 --> 00:02:32.741 They're going to credit bonds payable for always the face value, right? 00:02:32.741 --> 00:02:34.658 $2 million. 00:02:34.658 --> 00:02:39.839 Alright, and we clearly said this was issued at a premium, so we know 00:02:39.839 --> 00:02:42.938 just by looking at this, to balance our entry, we're going to have to credit 00:02:42.938 --> 00:02:53.169 $80,000 credit to premium on bonds-- I'll just put BP-- bonds payable. 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 00:02:59.652 --> 00:03:03.517 discount, look at your journal entry and see where it needs to go. 00:03:03.517 --> 00:03:05.517 It needs to be a credit or a debit. 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 00:03:08.216 --> 00:03:10.897 bonds payable has a normal credit balance. 00:03:10.897 --> 00:03:15.648 It's an adjunct account, meaning it comes alongside the bond payable, it actually 00:03:15.648 --> 00:03:17.848 increases the bond payable. 00:03:17.848 --> 00:03:22.396 Where as, the discount on bonds payable is a contra-account. 00:03:22.396 --> 00:03:25.728 It is the opposite, so it's a debit. 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. 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 00:03:37.093 --> 00:03:41.325 by 20, that's the number of interest payment periods. 00:03:41.325 --> 00:03:51.689 And that would be $4,000 per interest payment period. 00:03:51.689 --> 00:03:56.955 Okay, so we're-- the question is asking us to determine the interest expense 00:03:56.955 --> 00:04:00.132 to be reported on July 1 and December 31st. 00:04:00.132 --> 00:04:02.530 So, let's just do it in the form of a journal entry. 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 00:04:09.547 --> 00:04:14.446 doing the straight line amortization, we know that we're going to debit 00:04:14.446 --> 00:04:20.826 interest expense, but with straight line amortization, the interest expense is 00:04:20.826 --> 00:04:23.491 the plug number, okay? 00:04:23.491 --> 00:04:29.342 We are going to credit cash because we're actually paying interest out, 00:04:29.342 --> 00:04:32.690 and at what rate are we paying interest out? 00:04:32.690 --> 00:04:36.106 So, 10% for 6 out of 12 months, right? 00:04:36.106 --> 00:04:38.739 So, it's at the stated rate. 00:04:38.739 --> 00:04:44.837 So we say, the face value of $2 million times the stated rate of 10 % times 00:04:44.837 --> 00:04:49.402 the time, which is 6 out of 12 months. 00:04:49.402 --> 00:04:52.651 Which would be the same thing as saying 5%, right? 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. 00:05:02.650 --> 00:05:07.581 And, we need to amortize that discount-- sorry, excuse me, premium. 00:05:07.581 --> 00:05:11.464 And we determined that each interest period we're going to amortize the 00:05:11.464 --> 00:05:13.495 premium by $4,000. 00:05:13.495 --> 00:05:17.913 Now, remember, the premium has a credit balance, so to amortize it, I need to 00:05:17.913 --> 00:05:19.347 debit it. 00:05:19.347 --> 00:05:27.510 So, I'm going to debit premium on bonds payable $4,000. 00:05:27.510 --> 00:05:32.226 And then, the difference between what we paid in cash and the premium that we 00:05:32.226 --> 00:05:35.325 amortized is going to be our interest expense. 00:05:35.325 --> 00:05:37.825 So, $96,000. 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 00:05:44.906 --> 00:05:50.672 expense-- sorry, premium-- the interest expense per period is reduced. 00:05:50.672 --> 00:05:55.244 Why? Because you received more cash up front, so the amount that you're-- 00:05:55.244 --> 00:06:00.526 you're paying interest on a smaller face value, but you received more cash. 00:06:00.526 --> 00:06:04.190 So, it's effectively reducing your interest rate because you received 00:06:04.190 --> 00:06:06.557 more cash up front. 00:06:06.557 --> 00:06:11.406 And then on 12/31, the entry would be similar. 00:06:11.406 --> 00:06:16.104 We're going to debit interest expense. 00:06:16.104 --> 00:06:21.237 We're going to debit premium on bonds payable. 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. 00:06:25.269 --> 00:06:29.752 And then, we're going to credit-- and this one is payable on January 1st. 00:06:29.752 --> 00:06:42.815 So, we're going to credit interest payable $100,000. 00:06:42.815 --> 00:06:48.295 And again, the interest expense is going to remain the same at $96,000. 00:06:48.295 --> 00:06:51.528 Alright, let's do part B then. 00:06:51.528 --> 00:06:59.326 Um, Ron Kenoly Inc. issued $600,000 9%, 10-year bonds on June 30th of '25 00:06:59.326 --> 00:07:02.908 for $562,500. 00:07:02.908 --> 00:07:07.622 This price provides a yield of 10%. 00:07:07.622 --> 00:07:10.241 Okay, so we have 2 different interest rates. 00:07:10.241 --> 00:07:12.006 9% is, what? 00:07:12.006 --> 00:07:17.187 9% is the stated rate, and 10% is the market rate, 00:07:17.187 --> 00:07:19.055 or the effective rate. 00:07:19.055 --> 00:07:25.587 Interest is payable semiannually on December 31st and June 30th. 00:07:25.587 --> 00:07:30.068 If Kenoly uses the effective interest method, determine the amount of 00:07:30.068 --> 00:07:36.783 interest expense to record if financial statements are issued on October 31st of '25. 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. 00:07:40.649 --> 00:07:45.731 So, not only are we using the effective method, but we are also only calculating 00:07:45.731 --> 00:07:49.414 interest expense through October 31st. 00:07:49.414 --> 00:07:55.478 Okay, so first, again, let's go ahead and record the issuance of the bonds. 00:07:55.478 --> 00:08:03.593 They issued the bonds on 6/30, and they're going to debit cash. 00:08:03.593 --> 00:08:11.259 They said they received-- they told us how much they received-- $562,500. 00:08:11.259 --> 00:08:16.758 And, we're going to record a credit to bonds payable always for the face value, 00:08:16.758 --> 00:08:19.091 which is $600,000. 00:08:19.091 --> 00:08:25.206 Which means they recorded those bonds at a discount. 00:08:25.206 --> 00:08:34.888 And so, we're going to debit discount on bonds payable for $37,500. 00:08:34.888 --> 00:08:37.203 That's going to balance our entry, right? 00:08:37.203 --> 00:08:43.985 Alright, now, assuming that we are going to issue financial statements on September 31st, 00:08:43.985 --> 00:08:46.068 what do we need to do? 00:08:46.068 --> 00:08:49.133 We need to make sure that those financial statements are up to date with regard to 00:08:49.133 --> 00:08:53.982 interest expense and interest payable. 00:08:53.982 --> 00:08:56.682 How much do we owe at that time? 00:08:56.682 --> 00:09:07.844 So, on 10/31/25, we're going to debit interest expense. 00:09:07.844 --> 00:09:12.027 And, how much interest expense would there have been? 00:09:12.027 --> 00:09:16.276 How do we calculate using the effective method--the effective interest method? 00:09:16.276 --> 00:09:20.359 Well, if we look-- if we net together the discount and the bonds payable, 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. 00:09:30.208 --> 00:09:35.939 So, when we say that's our debt outstanding from 6/30 to 12-- excuse me, 00:09:35.939 --> 00:09:38.487 to October 31st. 00:09:38.487 --> 00:09:43.305 So, all of July, August, September, October, so 4 months, um, interest 00:09:43.305 --> 00:09:45.353 has been accruing. 00:09:45.353 --> 00:09:48.935 So if we take this to calculate our interest expense using the effective rate, 00:09:48.935 --> 00:09:53.518 we're going to say times the effective rate of 10%, or the yield rate. 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. 00:09:59.633 --> 00:10:08.848 So, we're going to debit interest expense by $562,500 times 10% times 4/12. 00:10:08.848 --> 00:10:15.445 That would be $18,750, okay. 00:10:15.445 --> 00:10:23.312 And then, we're going to credit interest payable, and this is going to represent, what? 00:10:23.312 --> 00:10:27.477 How much cash we have due at this moment. 00:10:27.477 --> 00:10:30.226 And so, how do you think we would calculate the interest payable? 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 00:10:40.874 --> 00:10:49.137 right now would be the face value times the stated rate times time. 00:10:49.137 --> 00:10:54.971 So in this case, the face value is $600,000 times the stated rate, which 00:10:54.971 --> 00:10:59.769 is 9%, times 4 out of 12. 00:10:59.769 --> 00:11:07.902 And so, if we do the math there, that's $18,000. 00:11:07.902 --> 00:11:13.982 Now remember, when we use the effective interest method, what is the plug? 00:11:13.982 --> 00:11:17.814 The plug number is the discount or premium amortization. 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 00:11:21.964 --> 00:11:28.164 to make it smaller-- discount on bonds payable, the difference is going to be 00:11:28.164 --> 00:11:35.395 $750, so that's going to be our amortization, okay.