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Issuing Bonds at a Premium

Brian Krogol
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All right? 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 check out our bonds, we're offering 12% and the market all the similar bonds to our bonds are only offering 10%. People are gonna prefer ours. Right? Ours are more enticing because we're paying higher interest rate. So this is when a premium exists is when the stated rate is greater than the market rate. Okay, let's go ahead and do our our summary table right quick. And remember we've dealt with these other ones already. We dealt with a 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 1st 2018 abc company issues $50,000 of 9% bonds payable, maturing in five years. So remember this, $50,000. 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 bonds say they're gonna pay 9% interest um And they mature in five years. Right? So it's five years. Five year bonds and interest is payable semiannually, which means two payments per year, right? Every six months we are going to make interest payments. So you might see annual bonds or semi annual bonds. Either way, semiannual tend to be more common because it's a little more complicated. We gotta make two payments per year. Okay january 1st and july 1st 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 going to be sold at a premium and that's exactly what we see. Right here, the bonds were issued at 108,000. Excuse me? At 100 and 880% of their face value. So the 108 means 100 and 8% of the face value. Now, that could have been any number, but they had to give it to you right in this case they sold for 108 uh percent of the face value. So let's go ahead and see how much cash we received. Right? That's what it tells us. That one oh eight tells us how much cash we received. And that's gonna be the 50,000 times 1.08 right? Because it's 108%, 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 gonna receive from selling these bonds. So that's gonna be our debit to cash, we're gonna receive 54,000 in cash. Okay so that is our debit um in this entry and we're gonna 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 gonna 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 those 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 4000 more credits. So we're gonna need 4000 more in credits over here. And guess what? That's gonna be. That's gonna be our premium on bonds payable premium on the bonds payable. I'm gonna put premiums on BP. That's usually how we abbreviate this premiums on bond payable. Okay so that 4000 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 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 4000. 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 sheets gonna show this cash we receive the 54,000. It's going to 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 4000. So when we show our balance sheet it's gonna show a bonds payable of 54,000. Or excuse me, not just the bonds payable, the bonds payable plus the premium is gonna show a balance of 54,000. Okay. And that's equal to the cash we received. So our 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 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