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Effective Interest Method:Amortization Table

Brian Krogol
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Alright so on the previous page we calculated the beginning value of this bond, we've calculated the price and the amount of cash that we collected. So what we're gonna do is use this table to calculate our interest expense. Each period are cash amount that goes to the credit in the interest expense entry and the amortization of that discount. Okay so let's go ahead and use that information to do this table here. Okay So remember on January 1, 2018 well that's when we sold the bond right, it had a beginning value as we saw was 96,149. That's what we calculated right, 96,149. Well on that date we don't pay any interest nothing. The discount balance is going to be that full balance that we started with 3851. And we're gonna have our ending caring value is the same as the beginning at that point. Right? There's no interest been paid yet. So we're gonna have the 96849 as the carrying value of the bond. Okay so remember the interest payment. So as time passes we're gonna start paying interest and this is going to be the cash interest payment here. So remember when we do this it's going to be our principal amount times our stated rate and then we'll divide by two if its semiannual in this case it was semiannual right? It was a semi annual bond as you can see right above. So we will divide by two. So our principal was 100,000 Times The 9% was our stated rate .09 times are excuse me divided by two. Right? Because it is semiannual so we will divide by two and this will give us our constant cash payment that we're gonna make every period. Right? Remember the cash payment does not change in this case because it's always gonna be the same stated rate and same principle amount 100,000 times point oh nine divided by two. It's always going to be 4500 will always be our our cash payment of interest every period. Okay so that's what we're gonna put remember now it's been half a year. So we're looking at july 1st 2018 so we would have started the year with the beginning value in the bond of 1 96,049 we're gonna pay cash interest of 4500. Right now what about our interest expense? How did we say? We're going to calculate that? That's going to be the carrying value of the bond times are market rate and we'll divide by two if the if its semiannual and in this case it is semiannual. So what are we gonna do? We're gonna take the carrying value times 0.10 right. It told us the interest rate on the market was 0.10 and then we're gonna divide it by two. Okay that is how we're gonna calculate it in this case notice I wrote carrying value because that's gonna be changing every period. So we're gonna have to do this calculation every period. So let's do it for this first period right here. What is going to be the interest expense? It's gonna be the 96,149 times 20.1 divided by two. And the interest expense comes out to be we're gonna be rounding here every now and then. We don't want to have a bunch of decimals. So we're just gonna keep the math simple. 4807. Right I remember the discount amortization that's gonna be the difference between the cash and the interest expense. Okay and that's gonna be changing from period to period as well. The cash minus the interest expense. And don't worry about signs if one's positive or one's negative. Remember when the journal entry? We never have signs, we just have the number. So we'll do 4807 -4500. And we're gonna get discount amortization of 307. So right here these three numbers that we just calculated that is our interest expense. Journal entry, we would debit interest expense for 4807. Credit cash for 4500 credit discount on bonds payable for 307. Okay we'll see that down below, we'll get more into the journal entries but let's go ahead and finish filling out this table using uh the this method. Okay so how do we calculate the discount account balance? Well it's going to be the previous balance minus amortization during the amortization during the current period. So previous balance minus amortization will give us the new account balance. So 3851 minus the 307 right, 8 3051 while we advertise 307 of that. So that's no longer part of the balance and we're gonna be left with 3544. Okay so how do we get to the ending carrying value? Well that's gonna be the face value of the bond face value minus the discount balance. Right? Just like we saw when we did the straight line method, the face value minus the discount uh amount it kept getting us to the to the carrying value. And just like we have in our formula above. So our our our our face value is always going to be 100,000 in this example. Right? And then we're gonna subtract whatever the discount balance is. Okay so we have 100,000 in in face value minus in this case 3544. So 100,000 minus 3544 gives us 96,456. So now the bond if we're gonna release our financial statements for july 1st we would show a balance of 96 96,456 for these bonds. Okay, so let's go ahead and fill in the rest of this table using the same logic. So we start at 96,456 for the next period. Right? And we're gonna have the same amount of cash interest. This will never change, right? Because we had um the same principle balance times the same stated rate divided by two. That gives us 4500 again. But now what about our interest expense? Now we're going to multiply 4 96,056. Our new carrying value. Let me leave the formula on the screen. There are carrying value of 4 96,056 times the 10% divided by two. And that's gonna give us our interest expense for this period of 4000 823. Okay, so interest expenses now. 4823. So the difference between the 2, 4008 23 and 4500, that comes out to 323 and there we go. This is our interest expense. Journal entry for the next period. Right? So notice the interest expense. Journal entry changes every period. That's why this method is much more difficult than the straight line method. But this is the method that gap proposes and the reason for it is because it more closely relates what you would have paid an interest had you used the market rate to start with. Okay, we don't need to go too much into the details other than how to calculate it here. Okay, so this is the gap method. Let's go ahead and finish filling out this table. So the discount account balance. Well that's our previous balance of 5 3044 minus 3 23. And that gets us to a balance of 3221. Okay, so our face value of 100,000 minus the discount balance, notice that this keeps getting bigger as we get closer to our maturity date and you can expect by maturity that it's going to be the full $100,000 balance. So our ending balance in that period is gonna be the beginning balance in the next period, 96,007 79. Our cash interest stays the same. 4500. Okay. Our interest expense. Well now it's gonna be our new carrying value 96 779 times 10% divided by two. And we're going to get 4839 as our interest expense in that period. The difference between the 2, 339 and there is our interest expense journal entry for that period, those three numbers. Cool. Alright let's keep it going. You can see that this is kind of just a flow now. Right? 2882 is gonna be the balance here and 97,000 118 right, we got that new discount balance by taking the previous 3000 to 21 minus the 3 39. Got us to the new balance and then 100,000 minus that discount balance is our new carrying value. What I want you guys to do is pause right here and I want you guys to finish filling out the table and then come back and let's see if you did it correctly. So I'm gonna wait five seconds while I wait for you to pause it and get guilty and if you don't you'll just see me finish the table up and you'll get no extra practice. Alright, so I'm gonna wait here. Alright I'm guessing you guys paused it and now you're back and you're ready to finish up the problem. Let's go ahead and see how you did. Okay, so our new carrying value is gonna be the 97118 to start this period. And what do we got? 4500, we're gonna do 8 4056 356 for our discount amortization. And our discount account balance is going to be 2526 right? If we subtract 100,000 minus 5 2026 we're gonna get 97,474. Now, I want to make a note to you guys. If you guys were to see this on a test, I would not expect you to have to do this whole effective interest table for for 10 payments. Right? This would take forever. They would usually just ask you for the first few payments to make sure that you understand how this works. Right? So let's keep going here and let's see how this finally uh finishes out. So 4 97,074 was our ending balance there and then we're gonna have the same 4500. So what's going to be this one is 4,874. And notice how our interest expense keeps climbing throughout the period because our caring value is higher each period. Okay, so 3 74 there's our interest expense journal entry. We're left with 2152 which gives us an ending balance of 97,848. Okay, let's go ahead and finish these up. So 8 97,048 guess what? Our cash interest is gonna be the same every period. Now our interest expense this period is 4,892,. In our amortization leaving us with a balance of 1760 which gives us an ending balance of 98,240, which is our beginning balance of the next period. And guess what cash interest is the same And what is our amortization or interest expense this period? 4912 so 412 is our discount amortization. The difference between the two. There's our journal entry for interest expense. 1348 is our discount balance after that amortization which gives us an ending balance of 6 98,052. So notice how our ending balance has been increasing this whole time. Right? Let me get out of the way here, notice how the ending balance has been increasing this whole time because we're getting rid of the discount right? We're advertising the discount And it's increasing the ending caring value of the bond as we reach maturity where it will equal 100,000. So 98,006 52 And our cash interest 4500 9 4033 in interest expense. 433 will be our discount amortization leaving us with 915 here in our discount account 99,085. All right, so we're almost done here 99,000 and 85. So we're still paying 4500 interest cash. Our interest expense is now 9 4054 which is 450 foreign discount amortization leaving us with 461 in our discount account balance leaving us a 99,539. And I want to note something about the last period in the last period. We need to get rid of the remaining discount balance right? We have this much in our discount balance. Well we're not gonna do the same formula anymore. We just know that our discount needs to disappear. So that is going to be the amount of our discount amortization in the final period 461 we know we're gonna pay cash the same amount 4500 And now we're going to plug in our interest expense. That's just the 4,961. The sum of this and this together. Right? So we didn't really do the same exact formula in the final year because it's a plug to make sure that all of our numbers work out, we no longer have a discount balance And we've got 100,000 as the carrying value of the bond. So now it's the final day, it's maturity day and the carrying value of the bond, 100,000 is equal to the face value of 100,000. The amount that we're going to pay back to the investors. That was a lot of work right. There were a lot of number crunching that went on and that's why they call us the number crunching accountants here. Okay, so we just learned pretty much the hardest thing that you learn in this course. Let's go ahead and see how this translates to the journal entries in the next vid.