**Unformatted text preview: **Accounting for Bonds Payable | Principles of Accounting 00:00:00
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Suppose that the town of Blue sold series a bonds with the face amount of 50 million dollars and a stated rate of interest that 10% and 97. 00:00:16
The bonds will mature in 30 years and pay the stated rate of interest twice a year. 00:00:23
These bonds sold at 97% of face value, or $48,500,000. 00:00:29
The difference of $1,500,000 is the discount of bonds payable. 00:00:34
The reason the bonds sold at a discount is because the market rate of interest is greater than the stated rate of 10%. 00:00:42
And therefore investors are only willing to buy the bond at less than full price. 00:00:46
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Suppose the bonds were issued on January 1st. 00:00:50
On January 1st, Blue would recognize receipts of $48,500,000 in cash, but he would also recognize a bond payable liability of $50,000,000. 00:00:59
The debit shortage of 1,500,000 is the discount on bonds payable. 00:01:07
Think of discount on bonds payable as prepaid interest. 00:01:10
This is the interest the issuer of the bond prepaid to bond holders by way of discounting the bond price upfront. 00:01:18
As part of the recognition of the bond discount over time, the amortization process begins by dividing the total discount by the life of the bond. 00:01:27
Therefore, the $1,500,000 will be amortized equally 30 years and twice a year, for a total of 60 periods. 00:01:35
There are a few ways to amortize discounts. 00:01:38
Assume that the town of Blue uses the straight-line method of amortization because it's the simplest. 00:01:44
Blue would make an entry on June 30th to recognize the bond discount amortization and the semi annual interest payments. 00:01:52
Note that the bond holders will only receive $2,500,000 in cash. 00:01:57
Which is the stated rate of the bond 10% times the face value of the bond $15 million divided by 2, since interest is paid semi annually. 00:02:06
However, the interest expense is $25,000 higher because it includes the amortization of bond discount, which is more or less like prepaid interest. 00:02:15
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Bonds can also be sold at a premium. 00:02:21
Suppose that the town of Blue sold serious a bonds with the face amount of $50 million and a stated rate of interest that 10% at 103. 00:02:30
The bonds will mature in 30 years and pay the state of rate of interest twice a year. 00:02:36
These bonds sold at 103% of face value or $51,500,000. 00:02:42
The difference of $1,500,000 is the premium on bonds payable. 00:02:48
The reason the bonds sold at a premium is because the market rate of interest is lower than the stated rate of 10%. 00:02:54
And therefore, investors are willing to buy the bond at a price above the face value. 00:03:00
Suppose the bonds were issued on January 1st. 00:03:03
On January 1st, Blue would recognize receipt of $51,500,000 in cash, along with a bond payable liability of $50 million. 00:03:12
The credit shortage of $1,500,000 is the premium on bonds payable. 00:03:19
As part of the recognition of the bond premium over time, the amortization process begins by dividing the total premium by the life of the bonds. 00:03:27
Therefore, the $1,500,000 would be amortized equally 30 years and twice a year, a total of 60 periods. 00:03:35
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Assume that the town of Blue uses the straight-line method to amortize the premium. 00:03:41
Blue would make an entry June 30th to recognize the bond premium amortization and the semi-annual interest payment. 00:03:49
Note, that the bond holders will receive $2,500,000 in cash. 00:03:54
Which is the stated rate of the bond, 10%, times the face value of the bond, $50 million, divided by two since interest is based semi-annually. 00:04:03
However, the interest expense is $25,000 lower because of the effect of the premium amortization. 00:04:11
Bonds are not always sold at a premium or discount. 00:04:15
If the stated rate of interest is the same as the going market rate, then they will simply sell at face value and there will be nothing to amortize. 00:04:23
Assume that the stated rate of interest on Blue's bonds is 10% and the market rate is also 10%. 00:04:29
The bonds would sell at face value, or $50 million in this example. 00:04:34
The entry would simply recognize the receipt of cash and the corresponding liability. 00:04:39
On June 30th, Blue would then recognize the 10% semi annual interest expense and cash payment, which will be identical, since it is not amortizing any premium or discount. 00:04:50
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