Bond Issuance Examples - YouTube

Now, next page it says issuance of bonds example and we're going to go through this example.

Face value of the bonds, million dollars.

Term, five year versus what?

Term versus serial bond which matures in installments.

Stated interest rate 8%.

That's how much cash I'm going to get.

I'm going to get 8% of a million dollars or $80,000 in cash but what am I earning?

That's a different question.

Then it says effective or market or yield is eight in example A, ten in example B, six

in example C. Notice that we're going to be doing three examples.

One is going to be eight, eight which is issued at par, issued at face.

We don't have to worry about the discounted premium then we'll go to a discount example,

then we'll go to a premium example and then life will be beautiful for you, things will

make sense.

Okay, so we've got eight, 10 and six.

Let's do that, so this is going to be example A, B and C. All right, so what do we have?

Five year term bond, million dollar face value, 8% stated rate, you're going to be paying

me interest of 80,000 and then we have par, discount, premium.

All right, so let's go through our example A. Now, in the first case I'm going to issue

the bond.

Now in this case it's real easy, there's no bond issue cost, there's no accrued interest.

There's nothing like that but we'll throw that in later to get even uglier.

We start out credit bonds payable always for face a million dollars.

I'm going to leave a few zeros off to save time.

Now, because there's no discount or premium, we're going to issue it for face, par a million

bucks.

Okay, now what's going to happen every year?

Every year you're going to pay me 8% of a million, I'm going to get some cash.

Okay, so I'm going to debit cash.

Now this is the guy that issued the bond, so let's start over.

Here's the bond issuer.

The person issuing the bond is going to do what?

He's going to credit cash for 80 and debit interest expense for 80.

Notice it's costing him 8% of a million or 80 grand, he's going to pay out that much

cash.

As far as the investor side, what is the investor doing?

The investor is debiting cash and crediting interest income, just the opposite debit cash.

The person buying this has an investment in bonds and a credit to cash.

They have an investment in bonds, credit to cash then they're going to have cash and interest

income.

I believe in the notes, I said, bonds issued a par where market rate is 8%, its debit cash

go to bonds payable.

Each year interest expense credit cash, okay.

The person buying it, the investor.

Now just so you know.

This section's going to mainly focus on the issuer because it gets more ugly however we

did mention investment in bonds remember debt or equity.

We have trading available held to maturity or bond you intend to hold until the, and

where do you keep them at?

Amortized cost which would be your face net of an amortized discount or premium.

We mentioned that back in the marketable security section, in the investment section just to

keep it in mind and at that time I said, bonds are a little tricky.

We'll talk about those later.

Guess what?

Now is later.

Hey, it's about time.

All right, the second situation in B, this would be a discount.

Now, in this case they're going to credit bonds payable always for face so a million

bucks.

Now, how much cash are they getting because you want to earn more than 8%?

I'm going to charge you less than 8% so I'm going to only get $900,000 upfront.

The difference is going to be the discount and let's say in this case it's a 100.

Now to keep it simple, I'm going to amortize the discount, one of two ways.

Straight line, not GAAP or effective interest method GAAP and that's going to use the same

effective interest table that you were introduced to in notes receivable in an earlier section.

However we're going to go into it in more detail because in that example there was no

cash being paid every year just not until the note was matured.

Now we're going to go through and have cash every year changing hands.

Now, to keep it simple.

It's a five year bond, that's 20 bucks a year.

What are we going to do?

They're going to pay out cash of 80 bucks.

They're paying the same amount, cash, cash, cash, cash because it's 8% of a million, that

is based on the stated, face, nominal, and coupon rate.

We're also going to amortize out the discount.

Now in amortizing out the discount, we're just going to amortize it straight line so

this is going to be credit amortization of discount taken out 20.

What is your plug?

Interest expense.

Notice it's going to be 100.

To keep it simple, remember, this is 8%, that's how much cash.

Here, cash 8% but remember at a discount you wanted to earn 10%.

I can't just erase the bond and make it from eight to 10 so I'm paying you 10% in cash

instead I charge you less upfront and what's going to be happening now is here's the cash

at 8%, here's your interest expense.

It's really costing me what?

10%, okay, the person who bought the bond would what?

They would debit cash for 80.

They would take out their discount on their investment and they would have interest income

of a hundred.

As we look at this, you'll see that this thousand net of a 100 is what?

900 that was called our carrying amount or our amortized cost and then every year what

happens?

We're going to amortize out of the 100, we're going to come out 20, 20, 20, 20 so the carrying

value goes 900, 920, 940, 960, 980 up to a thousand.

This goes to zero, get rid of the bond payable for a thousand, credit cash for a thousand,

we're done.

Do you see how we're amortizing it out but by amortizing the discount or premium, it

affects your interest expense and from the investor side the interest income.

The person who purchased it would affect their interest income and the issuer would affect

their interest expense.

Now the other thing that I want to mention here and this is for those that are a little

more advanced.

Maybe you've taken the exam, didn't pass it or you've already done a lot of studying and

this stuff will make sense.

With our statement of cash flows, let's think about it.

How much cash did we pay out?

You paid out 80 but how much is on our income statement as expense.

You have interest expense of a 100.

On your statement of cash flows, you're going to think you paid out a 100 but you really

only paid out 80 which means don't I still have 20 grand in my pocket?

Yeah, on a statement of cash flows, you add back a discount.

You add back a discount but you take out a premium.

You'll see that in a minute.

That's what's happening in this case.

Let's now go on to example C which would be a premium.

That means that you're paying me 8% but I only want you to earn 6%.

We start out credit bonds payable for a million.

We're going to debit cash, I'm going to charge you a million one upfront.

The difference is called a premium for a 100.

Notice, what's the carrying value?

What is the amortized cost of the bonds?

It's a million one.

What does it have to go down to?

It has to go down to a million.

In a discount, what happens?

It starts at 900 and it's got to go up, up, up to a million.

Notice in a discount it starts small and gets bigger.

In a premium, it starts big, a million one and gets smaller.

That's the issuance then what are we going to do?

We're going to pay out cash every year of 80.

We're going to take the premium, we'll do it straight line just to keep it simple.

100 over five is 20, so we will take out amortization of premium for 20.

What is your plug?

Interest expense.

Notice interest expense is the plug for 60.

I'm paying you cash of eight but you're really only earning six.

That's how you play with the interest rate so I want you to earn less.

I'm going to charge you more upfront.

I want you to earn more.

I'll charge you less upfront.

That's why if the stated rate which is 8%, the stated rate is less than the effective

rate, that's a discount.

If the stated rate is in this case 8% is greater than the effective rate then we're going to

have a premium.

That's what's happening as far as the amounts and as far as the amortization.

Now, same thing here on the statement of cash flows.

What is the difference?

On a statement of cash flows, here, my expense is 60 but it really cost me 80 so I have less

cash, back out the premium.

Add back the discount, back out the premium.

Add back the discount, back out the premium.

It will make more sense after we cover cash flows which we're going to cover in about

in a little while.

Okay, the reason I cover cash flows towards the end, it involves so many transactions

that you may not be familiar with because it deals with assets, liabilities, equity.

We haven't talked about stockholders equity so I don't want to talk about how to manipulate

those journal entries until we've learned them.

Make sense, sure.

Okay, so that's what's happening.

Again, I want you to understand the concept about issue to par or face value versus a

discount, versus a premium.