F4 - M5 - Bonds: Part 2 Flashcards
What is amortizing the bond using the straight line method?
This one is pretty simple, you just find the discount or the premium, and divide it by the life of the term, and that is the amount you amortize over a periodic basis. L
Let’s say that the discount is 150,000 and the bond is issued for 1,000,000. Also lets add that the bonds mature in 6 years. How this works is that the 150,000 divided by 6 is 25,000. That 25,000 is then amortized over six years and decreases the discount entry by 25,000 and then increases the carrying value each and every year.
What is amortizing the bond using the effective interest rate method?
This one is a little more tricky, you need to find the difference between the interest expense and the actual interest paid, and that is the amount that you will amortize the discount over the life of the bond.
So if the bonds are issued at 8% and they have a face amount of 1,000,000, we know that the interest paid is 80,000. Let’s say the discount rate is 150,000, face value minus the discount will give us the carrying value of (1,000,000-150,000) * .12 = 102,000. That 12% lets assume was the market rate. The difference between those numbers (102,000-80,000) = 22,000 which is what you would amortize. Then your new discount balance is 128,000 (150,000-22,000), which will increase the carrying value to (1,000,000-128,000) 872,000. Then do it all over again next year.
Under the discount method is the interest expense greater than the interest paid? What about for premiums?
Under discounts, the interest paid is less than the interest expense, under premiums, the interest paid is greater than the interest expense.
What is the journal entry for payment of of interest on a bond at a discount?
Debit - Interest Expense
Credit - Amortization of bond discount
Credit - Cash or interest payable.
What is the big takeaway when using the effective interest method when amortizing?
To find the interest paid, just take the face value of the bond times given interest rate that the bond was issued at.
To find the interest expense, take the carrying value times the effective interest rate for amortization.
The difference between these numbers is what you amortize.
When using the effective interest rate method, how is interest payable calculated?
You take the face value of the bond at the beginning of the period times the contractual interest rate.
If the bond was issued between interest payment dates, do you have to accrue interest?
Yes, so lets say that the bond was issued in April, and interest is paid on January 1st and July 1st. You would not only get the bond payment amount, but the interest that was accrued between January and April.
