Bonds – discount and premium

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    Topic
  • #1577729
    terpgirl
    Participant

    Hi everyone!
    happy Saturday/study day XD

    I am working through Bonds part 2 in Becker. Can someone “dumb down” the concept of the premiums reducing interest expense or discounts increasing interest expense? The part I am struggling with is when the value is pulled back up to par value etc. Does that even make sense what I am asking?

    Thanks in advance! 🙂

    Aud - 60,70,72,69,80 (2/19/16)

Viewing 5 replies - 1 through 5 (of 5 total)
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  • #1577734
    mccarta7
    Participant

    Hi! I've been working on non-current liabilities all day today and focusing heavily on bonds as well. I think I understand what you are asking. I also really struggled with bonds, but am feeling pretty confident after my day of studying them today. Looking at bond premium and discount amortization schedules and journal entries really helped me visualize the process.

    To calculate annual cash paid for interest on a bond, multiply the face amount given times the stated rate. These amounts are usually the ones given first in a problem. This amount will remain constant over the life of the bond.
    To calculate the annual interest expense, multiply the carrying amount (the face amount less discount or plus premium) by the yield (effective rate). The carrying amount will change over periods as you add or subtract the premium or discount amortization.

    The difference between these two amounts is the amount of amortization added to or subtracted from the carrying amount of the bond. If the carrying amount is higher than the face amount, you know that you need to subtract this amount. If the carrying amount is lower than the face amount, you know you need to add this amount.

    I hope this helps a little!

    #1577788
    Mike J
    Participant

    Know that with a discount there is MORE interest than with a premium.

    This is the same whether the point of view is as the issuer or Investor. The calculation (second poster) is also the same.

    The differences lie in the journal entries. From an issuer: Dr Cash (selling price); Cr Bond Payable (face amnt); Dr/Cr Discount/Premium on Bonds. Selling price equals = (Face x PV$1) + (Face x Stated int x mo/12 x PVOA). Discount or Premium depends on how you need to balance the formula.

    For the Investor, you are paying cash. So that's a credit to cash to decrease the asset. Debit to Investment in Bonds. The figure is the same selling price value.

    Like I said above, remember that discount situations yield more interest. For issuer, Dr Int Expense (expense is most often debits; Carrying Amount of Bond x MARKET int rate x mo/12). Credit Cash (ALWAYS same each int PMT for this bond: Facebook Value x STATED int rate). Dr/Cr Discount or Premium to plug.

    For Investor: Debit Cash for the int check; opposite side of cash entry for issuer. Credit Interest Income; again, opposite side of the interest expense entry for issuer but this is income. Balance with discount or Premium.

    The fun begins when you have to issue between dates. Essentially, you're assuming the seller will charge for the accrued interest from last int date until date of sale.

    For Investor: (1) Debit Cash bc you're getting cash. That is a total figure or a plug. Credit Bond Payable for the face amount (sound familiar so far?). Credit Interest Payable (face x int rate x #mos after prev int date/12).
    (2) Debit Int Exp (face x int x mo/12). Debit Int Pay (pay back int from (1)). Credit Cash (plug). Then proceed as if transacted on the interest date.

    Lastly, if you have to REtire think REverse the original journal entry. eg if Bond is called.

    That should be enough. Hope this helps.

    #1577876
    mccarta7
    Participant

    Thanks for the additional tips @mike030882 ! Some of those were helpful for me as well.

    #1577950
    Mike J
    Participant

    You're welcome. Bonds can get complicated very quickly. But, becoming very comfortable with the journal entries can help get you out of trouble.

    In fact, that's true of most of the FAR topics.

    #1579711
    terpgirl
    Participant

    Thank you both so much!! This helped me. Sorry for my late reply.
    Happy 4th 🙂

    Aud - 60,70,72,69,80 (2/19/16)

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