Bonds (FAR Exam Nuggets)

Hi guys, I feel like my wheels are spinning on the same spot on Bonds.  Help! - Kingston G.

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Try to put it into a logical context. If you "issue" bonds, you are borrowing money. Somebody gives you money and you promise to pay them interest every period and the principal amount at the end of the contract term. If the market rate is higher than the contractual rate, then the market bonds are more attractive, so you have to discount your bonds to make them competitive. If the market rate of bonds is lower than your contractual rate, then your bonds are very valuable and sell for more than par (premium).

Study the journal entry for issuing bonds: Dr: Cash Dr: Discount on BP, Cr: Bonds Payable. Conversely, if it's a premium, then the premium entry goes on the same side as the Bonds Payable, a credit. If you remember this and understand this, you can solve any problem with bonds.

When time passes and you amortize the discount, the amortization entry goes on the opposite side of the original discount entry. As long as you understand the original journal issue for issuance of Bonds, you have it mastered. Everything else is just logically tracing it out to the proper period and answering the question. Hope this helps. Good luck!! 

Oops, let me make this last part a little clearer. If the original issue was a discount, therefore a debit to Discount on BP, then when you amortize, the discount will be a credit - opposite of the original entry.

Always set up a makeshift amortization table when using the effective interest method. Makes it all clear. You can trace out your carrying amount to any period it asks for. Usually, however it will only be a period or two into the future, because of time when using the effective interest method. If it's the straight line method, which is often used on the exam, its even easier. Calculate the total discount on the bonds at issuance, then divide it by the number of periods under contract and that's your entry for every period. Same journal entry every time for straight line method.

When you calculate the original discount, remember if it's $500,000 of bonds, and they sold for 450,000, then your discount is 50,000. You will be amortizing that discount over the contracted period of the bonds. Only two ways - effective interest method or straight line. Try to understand this conceptually, and you will learn to LOVE bonds. They are a very neat way for corporation to raise money and spread the borrowing over hundreds/thousands of creditors.

(effective interest method) Just take it one step at a time. What is the total amount of the bonds? Then what is the discount or premium? Then how often are payments paid? Then ----> Set up the amortization table. Remember interest expense is simply the carrying value times the market rate of interest (adjusted if needed for semi-annual payments). and the payment is the Face Value times the contractual interest rate (adjusted for semi-annual payments if needed). Set up the table and plug in these figures and you can answer ANY question.

The difficulty most people have with bonds is that when the problem is presented, there is SO MUCH information and it's easy to get confused. But take it one step at a time, and make that amortization table. And be sure you can do the straight line method, because the CPA exam uses it a lot, according to my study materials. - Steve B.