11. Long Term Liabilities
Premium on Bonds
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Alright, so let's move on to the premium on bonds payable now. I want you guys to go ahead and after this lesson compare the discount and the premium. And see how much they have in common and are basically opposites of each other. So what do you guys remember about the stated rate and the market rate when we're talking about premiums? So when the stated rate, let's say is 12%. Now, we're saying with our bonds. Hey, out our bonds, we're offering 12% and the market, all the similar bonds to our bonds are only offering 10%. People are going to prefer ours, right? Ours are more enticing because we're paying higher interest rate. So this is when a premium exist is when the stated rate is greater than the market rate. Okay? So let's go ahead and do our summary table right quick, and remember, we've dealt with these other ones already. We dealt with the situation where the stated rate and the market rate are equal, and this was a face value bond, sometimes called a par value bond, and the price of the bond will be equal to the face value in that case. Now, what about the situation we just discussed where the stated rate was less than the market rate? The stated rate is 8%, while the market rate is 10%. Well, the price of the bond is going to be less, right? Our our bond in that case is less enticing than the market, because we're offering less interest. So investors will pay less for it, and they will pay at a discount. Now, in this video, we're gonna be focused on the premium. That's a situation where we're offering more, just like we said. We're offering 12% when the market offers 10%. Well, the price of the bond is going to be greater than the par value. Right? And that's because our interest rate is higher, they're going to be sold at a premium. Okay? So let's go ahead and see how the issuance entry, when we first issue the bonds, what that's going to look like when we are dealing with a premium situation. Okay? So we have very similar details to our previous examples. On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable maturing in 5 years. So remember, this 50 dollars, this is the principal amount. The face value of the bonds. Okay. And that's the amount that will calculate our cash interest. The amount of cash interest we pay, that's gonna be dealt with this stated interest rate. The bond say they're gonna pay 9% interest, and they mature in 5 years. Right? So it's 5 years, 5 year bonds and interest is payable semi annually, which means 2 payments per year, right? Every 6 months, we are gonna make interest payments. So you might see annual bonds or semi annual bonds. Either way, semi annual tend to be more common because it's a little more complicated. We got to make 2 payments per year. Okay? January 1st July first is those interest payment dates. Now notice, the market interest rate in this case is 8%, right? We're offering 9%. The market is only offering 8%. Well, our bonds are more enticing. They're gonna be sold at a premium, and that's exactly what we see right here. The bonds were issued at a 108,000 or excuse me, at a 108, right? A 108% of their face value. So the 108 means a 108% of the face value. Now that could have been any number, but they have to give it to you, right? In this case, they sold for 108 percent of the face value. So let's go ahead and see how much cash we received, right? That's what it tells us. The 108 tells us how much cash we received, and that's going to be the 50,000 times 1.08, right? Because it's a 108 percent, which is 1.08. So let's go ahead and see what that comes out to. 50,000 times 1.08, well, that comes out to 54,000 and that's the amount of cash we're going to receive, from selling these bonds. So that's going to be our debit to cash. We are going to receive 54,000 in cash. Okay? So that is our debit, in this entry. And we're going to have a credit. We owe money now, right? We took on this liability for bonds payable. Well, what is going to be our credit to bonds payable in this case? Is it going to be 54,000? No, just like we said, right? The bonds payable is always going to be in the amount of the face value. The face value of these bonds are 50,000 and this always has to be always face value going into the bonds payable account, okay? 50,000 is the bonds payable, but this doesn't balance, right? We've got debits of 54,000 and credits of 50,000 in this case. So we need 4,000 more credits. So we're going to need 4,000 more in credits over here and guess what that's going to be? That's going to be our premium on bonds payable. Premium on bonds payable. I'm gonna put premiums on VP. That's usually how we, abbreviate this, premiums on bond payable. Okay? So that 4,000 extra is going to be sitting in another account. We keep the principal account in the bonds payable account, and then we have this related account. Not necessarily a contra account account because it's increasing the value, right? It has a credit balance. We have the credit balance of 50,000 plus another credit balance of 4,000. So it's increasing the value of bonds payable based on this extra cash we received. Okay? So when we see our balance sheet, our balance sheet is gonna show this cash we received the 54,000. It's gonna be increasing our cash balance. But on our liabilities, now we're gonna be showing our bonds payable account. So when we show our balance sheet, we're gonna have our bonds payable account sitting on 50,000 as a credit, right? It's gonna show a liability of 50,000, but it's also gonna say plus premium, right? Because the carrying value of the bond is not just the 50,000. It also has this premium associated with it of 4,000. So when we show our balance sheet, it's going to show a bonds payable of 54,000 Or excuse me, not just the bonds payable. The bonds payable plus the premium is going to show a balance of 54,000, okay? And that's equal to the cash we received, so our equation stays balanced here. Okay? So it's a big note when we make our journal entry, that the bonds payable account always just has the face value of the bonds, and then we store the difference difference from the cash we received and the bonds payable in either the discount or the premium. Okay? So let's go ahead and move on to our interest expense journal entry.
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