Issuing Face Value Bonds

Brian Krogol
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Alright let's start with the easier case of face value bonds. Remember the face value bonds. This is where the stated rate and the market rate are going to be equal. So let's check out this simpler example. So bond is issued at face value when the stated rate is equal to the market rate. Okay. So that means that our bonds were saying hey everybody come buy our bonds that we're offering 10% interest and everyone else on the market is also offering 10% interest. So since it's equal, they're going to be sold at face value. Okay. And uh sometimes we get into why we priced the bonds like this and it has to do with present value calculations. Okay so present value, this has to do with the time value of money. And it's saying if we take back all the value of the interest payments and the principal payments we're going to get in the future. What's that worth to me today. Okay. And some of you are going to go into a little more calculations with that and some of you won't. So that's the main idea of how these prices come about. But in this class we usually don't go too deep with it. Alright, so let's go ahead and start thinking about, we're gonna have this table at the top of the next few pages as a summary to keep our head thinking about how the stated rate and market rate impact the selling price of a bond. Okay this is this is the biggest part of this chapter of what you need to memorize of when we're gonna have discounts, when we're gonna have premiums when its face value. It all has to do with this interest rate, the stated rate and the market rate. So when the stated rate equals the market rate, just like we're talking about right now 10% and 10%. Well, that's the price of the bond will be equal to the face value. Okay. And remember the face value of the bond, that's the principal amount. And in general when we talk about the face value, they're usually $1000 bonds, but we might sell tons of bonds. Right? So the face value of 1000 $1000 bonds is a million dollars. Alright, So we would have sold a million dollars worth of bonds for a million dollars in that case. Okay. So the, the stated rate equals the market rate when we sell at face value. Now let's look at our two other situations. It could be when the stated rate is less than the market rate and that would be a situation where the stated rate, we're saying, Hey, our bonds are offering 8% and the market is offering 10%. Well, our bonds are not as enticing to investors, right? So they're not gonna be willing to pay us the full the full face value. They will be the price of the bond will be less than the face value. Okay. And that will be a situation where we have a discount. And then the last situation, well this would be when the stated rate is greater than the market rate. Right now we're offering 12% when the markets offering 10%. Well the price of the bond will be greater than face value. Okay. So notice how the the stated rate and the price of the bond go in equal directions. Right? If we if we have a better stated rate than the market, well then the price of the bond will be greater than the face value. Okay so they go in the same direction, their premium on bonds when the stated rate is greater than market rate. But let's focus on this first situation where they're sold at face value and sometimes that's called par value as well. Same thing. Okay so let's go ahead and see how we make the journal entries for face value bonds. Okay, let's start here with bonds with the issuance of the bonds where we initially sell the bonds and then we'll deal with the interest expense entries and finally the repayment of principal. So let's start here with issuance on january 1st 2018 abc company issues $50,000 of 9% bonds payable, maturing in five years. So notice $50,000. This is the principal amount. The face value. Now this principle amount might not be the amount of cash we actually receive the amount of cash we actually receive depends on that percentage. Right? When they tell us we're gonna sell them for 100%, 100 three%, 92%. Remember we did those examples? Well that's gonna tell us how much cash we actually receive. Another way we can see how much cash we receive is to compare the interest rates if the interest rate in this case, they told us we have 9% bonds payable. Well this is the stated rate right here. This 9% bonds payable because that's that's where it states ICC company is issuing 50,000 of 9% bonds payable. That means they're gonna pay 9% and they're maturing in five years. So this is the maturity, maturity date is in five years. Interest is payable semiannually. So remember semiannual interest semiannually means twice per year. So it's not just gonna be one yearly that we pay interest, we're gonna pay it every six months basically that we pay the interest on January one and July one. And finally It tells us the market interest rate is equal to 9%. Right? So we've got the stated rate of 9%, the market rate of 99%. And that's why in this case we have face value bonds, right? We have the stated rate equal to the market rate. They could have also told us these bonds sold for 100 and that meant that they sold for 100% of their face value which would be equal to the face value. And this is why these are the easiest because the face value equals the cash received. Okay now I know we've gone through a lot of terminology there, right? We have our principal amount are stated rate, our market rate maturity period, there's a lot of information going on here. But you're gonna see as we go through more and more examples, this is gonna stay constant. You're gonna be given this amount of information every time. Okay? So you're gonna get used to it as we go on and on. So in this case we the stated rate equaled the face equaled the market rate. So we're going to receive the full face value of the bonds. Okay? They're gonna sell for face value and we're going to receive all of that amount in cash. So this journal entry, remember we're selling bonds here. We're selling a liability. We're gonna receive cash and we're gonna owe money later. Okay? So this journal entry, we're receiving cash. So we're gonna debit cash for $50,000 and then we're going to credit our bonds payable right? We have a liability now for bonds payable that we're gonna pay in the future and that's gonna be in the amount of 50,000. Okay? The bonds payable account will always hold the face value, okay will always Always be face value even when we're dealing with the discounts and the premiums. We always in the bonds payable account will put the face value of the bonds. Okay? So we'll see more details about that once we get to discounts and premium. Alright. So in this case we received cash right, the cash received was 50,000. So that increased our assets by 50,000. But how did we get that cash? How did we pay for it with a liability? Right now we owe 50,000 in the future. So we took on a liability for 50,000. Our assets increased our liabilities increased by 50,000. Alright, let's pause here and then let's start dealing with interest expense as time goes on.