11. Long Term Liabilities
Face Value Bonds
Issuing Face Value Bonds
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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.
Face Value Bonds:Interest Expense and Cash
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Alright when we deal with face value bonds, interest expense is really easy. It's just gonna be equal to the cash amount of interest that we pay. Okay, so let's go ahead and figure that out. So it told us that $50,000 of bonds are paying 9% interest while we take the $50,000 And this is the the principal amount of the bonds times the 9% .09. Let's find out how much that is. 50,000 times 0.9 that equals 4500. Okay, so 4500 is the yearly amount of interest that we're gonna pay right yearly interest because it's a 9% bond. But notice when we pay the interest in these cases and this in this example we're paying interest semiannually, which is twice per year. So we're gonna make journal entries every six months, every six months we're gonna owe interest and we're gonna take on our interest expense for those six months. And then the next six months will take more the rest of the interest expense for the year. So july 1st. Remember only six months have passed. We issued them on january 1st and now it's july 1st. So six months of interest, Oops, months of interest. Well that's gonna equal our yearly amount of interest, the 4500 divided by two, Which comes out to 2250. Right? So from January through July January through June those six months we we have to pay six months of interest which is half of the 9% right
Face Value Bonds:Interest Expense and Interest Payable
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All right? So as time continues, we're gonna have to keep paying interest. Right? But what's gonna happen before our next interest payment date, right? The next interest payment date is gonna be one january first. Rolls around. Well, we're going to issue our financial statements at the end of the year. On december 31st. Right? But that still means that the six months have gone by right, the other six months of interest have gone by. So we would still calculate it the same. We have the 50,000 in principle times the 60.9, Which gives us the yearly amount of interest, which we had calculated to be 4500 yearly. Right? But we divide that by two To get the six months of interest. Right? So we had already taken six months of interest expense in the previous journal entry in the previous video and now we're gonna take the next six months from July through December. So on December 31, 2018, we're going to make another journal entry for the other 2250. Okay, now this one's a little technical but in general it's it's just good to know how we're making this entry. So on december 31st 2018. Well what are we gonna do? We're gonna take our interest expense. Right, And that was since it's a face value bond, well, we know it was gonna be the 2250, but what's the other side? We haven't paid it in cash yet. We don't pay it in cash until January one the next day. So technically the cash is still in our pocket. So what we have is interest payable. Okay. On december 31st 2018 we have interest payable. We have this extra liability to pay this interest on january 1st. Right? We need to accrue for the six months of interest that have passed since july 1st. So we have to take the 2250 as interest payable. And that's going to be our interest expense as well in this case. Okay. And just to show you on january 1st. So on 11 2019 the very next day when we pay the interest, right? Because on december 31st 2018 we're issuing our financial statements but we haven't paid that cash yet. So we don't want to reduce our cash, it's still in our bank account as of that day, The very next day we pay it off and we're going to debit interest payable because we no longer have this liability for the interest payable and we're going to credit cash right? Because we're paying out in cash and that'll be the 20-50. So notice the difference between this set of entries and what happened in the previous page for our interest expense on July one. Well that was still during the reporting period and we paid it out in cash, we took the interest expense here, we had to create a liability on the last day of the year uh to accrue for those six months and then we paid it off on January 1st. Okay. So nothing too crazy. There were still seeing just our interest expense and just calculating our interest based on our stated interest rate, our principal amount, and then dividing it by two because its semiannual periods. Okay, so our interest expense and our interest payable notice what happens here? Interest payable? That's a liability, right? Because it's a payable And that's 2250. It's an increase in our payables and the interest expense. Well that lowers our equity just like we did in the previous uh journal entry up above. So we stay balanced here. Right? The liabilities increase, the equity decrease were good. And then once we make the next entry, the payable right in that blue entry, the payable decreased by the 2250 And the cash decreased by 2 2250. So that also stayed balanced there. Okay, so that's about it here, let's go ahead and move on to the next journal entry.
Face Value Bonds:Repaying Principal at Maturity
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All right? So you can imagine throughout the life of the, of the bonds, we would have kept making those journal entries every year, we would have kept taking interest expense every six months, we would have been taking interest expense for those six months, paying out cash interest payable at the end of the year. It would have kept happening every Year until we get to the final year and it's time to repay the principal. Right? Remember we had that bonds payable on our books for $50,000. We had this liability for $50,000. Well now it's finally time to pay it right January 1, 2023 comes around and it's time to pay off the principal. Now, one thing I want to note on January 1, 2023, right, because this is five years later when it's finally time to pay it off, we would have also been paying off this final amount of interest, right? We're paying interest semiannually every January one. But that that journal entry is going to be just like we did above where we had our interest payable and then we're gonna pay it off on January one and and close out the payable liability. So here let's just focus on the principal repayment, right? We're taking that $50,000. And now everyone's saying, Hey, it's been five years time to pay me back on my bond. Right? So now we have that $50,000 of bonds that have become due and we need to pay them back. So what's gonna happen is we're gonna pay them back and we have to get rid of our liability. So we're going to debit bonds payable, right? Because it had a credit balance, it was a liability with a credit balance of 50,000. Well, guess what? We're paying them back now. We no longer have that liability. So we debit bonds payable for 50,000 and we credit cash for 50,000, Right? We're paying them in cash. The 50,000 in cash is coming out of our pocket on January one and we get rid of the liability. We no longer owe them that liability. It's off of our books. So at this point, our bonds payable are liabilities decrease By the 50,000 And our cash decreases by 50,000 because of that credit. Right? So there we go. That's journal entry is pretty simple, right? We're just closing out of liability. We had a liability and we repaid it so we get rid of it. All right. So, that's about it. For face value bonds. Let's see how this compares to discounted bonds and premium bonds in the upcoming videos. Alright, let's check that out.