Skip to main content

Alright. So we had that $4,000 premium on the bonds over the life of the bond. We're gonna advertise that premium into our interest revenue to get rid of it. All we want left when the principal is repaid after five years is just the bonds receivable amount, just the principal value. So we're gonna be getting rid of the premium through our interest revenue. So let's see how this works. What we're gonna use is the straight line method for premium amortization. Now this isn't technically gap but it's it gets a lot more complicated. So we generally just use straight line method in this class because it's a little easier. Okay? So what we do is we take the total bond premium which in this case was the $4,000 right total premium. And we have to divide it by the number of interest periods. So how many interest periods are there in this example? Well it was five years, right? There's five years but interest is payable semiannually which is twice a year january 1st and july 1st. So if it's twice a year for five years, that means there's 10 interest periods right? Five years, times two is 10 total interest periods. So that gives us premium amortization of $400 per interest period. Okay. Now notice this is very similar to what we do with bonds payable. It's actually exactly the same. We're just on the other side of the situation. So all our entries are just reversed. Right now we have interest revenue instead of interest expense. Now we have interest receivable instead of interest payable, right? The cash is received instead of cash paid, everything is just reversed. So let's go ahead and see how this journal entry works out. We already know the amount of the amortization of the premium right here. $400. But let's go ahead and figure out the rest of the entry. Let's find out how much cash is going to be received. And from this interest payment. And it's gonna be the $50,000 of principle right? The cash interest that this pays is based on the stated rate when we sold when the when we bought this bond, they said, hey we're gonna pay 9% interest on $50,000 of principle. Who wants to buy it? And we bought it $50,000 of 9% bonds. So 50,000 times 9%. Which is 0.9. How much does that come out to? It comes up to 4500. But that's annual. Right? That would be the annual amount because 9% is the annual interest rate. So we need to divide it by two and it'll give us the the semiannual, 2250 semiannual. Right? And that's the amount that we need in our journal entry because this is a semiannual interest payment. So they pay half of it every six months, 2250. Okay? So we know we're gonna receive cash of 2250 and we have to advertise that premium. Remember the premium had a debit balance right when we look in the previous entry, the premium was increasing the value of our asset. So now we're gonna be getting rid of it with credits. It had a debit balance, we get rid of it with credits. So we're going to credit the premium for the amount of the amortization premium on bonds. And that's gonna be 400. And then what's left is our interest revenue. Okay. So we earn interest revenue from earning interest right time has passed. We've earned interest and in this case it's a plug that fills in our general journal entry. We know we we received cash interest of 2250. So we received that in cash. We have to advertise the premium of 400 And we're left with interest revenue of 1850. Okay. So remember this amortization of the premium. The reason we do this is because over time we're not gonna receive 54,000 when this bond matures, we're only gonna receive 50,000 which is the principal amount. So by advertising this premium over the life of the bond, we're getting rid of that premium. So that once the maturity date comes around all that's left on our books is the 50,000 in our In our bonds receivable. Cool. So in this journal entry we received cash of 20-50. So that was an increase to our assets. But the premium, which was an asset decreased by 400. So that's gonna decrease our assets and the interest revenue right here behind me. Interest revenue is revenue to the company. And that would increase by 1850 our equity, right? Because that's gonna increase our income. Cool. So now that we've seen it for premiums, let's go ahead and do the same thing for a discounted bond.

© 1996–2023 Pearson All rights reserved.