CHAPTER TWENTY-FOUR APPENDIX

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Presentation transcript:

CHAPTER TWENTY-FOUR APPENDIX CORPORATIONS: BONDS--EFFECTIVE INTEREST METHOD

EFFECTIVE INTEREST METHOD Method of amortizing premiums and discounts on bonds payable Effective interest rate market rate of interest on the date the bonds are issued used to determine the amount of interest expense and premium or discount amortization for the period

Market Rate of 8% for 1/2 year PREMIUM AMORTIZATION EXAMPLE: On April 1, 20-1 the stated rate of 9% is GREATER than the current market rate of 8%, so Watkin Corp. will sell the $400,000, 10-year bonds for $427,181. FORMULA: Carrying Value x Semiannual Effective Interest rate $427,181 4% x Market Rate of 8% for 1/2 year

PREMIUM AMORTIZATION $427,181 4% EXAMPLE: On April 1, 20-1 the stated rate of 9% is GREATER than the current market rate of 8%, so Watkin Corp. will sell the $400,000, 10-year bonds for $427,181. FORMULA: Carrying Value x Semiannual Effective Interest rate $427,181 4% x Interest Expense is $17,087

interest payment is computed GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Oct. 1 Bond Interest Expense 17,087 2 Premium on Bonds Pay. 3 4 Will be determined after Cash interest payment is computed 5 6 7 8 9 10 11

GENERAL JOURNAL Oct. 1 Bond Interest Expense Premium on Bonds Pay. DATE DESCRIPTION DEBIT PR CREDIT 1 Oct. 1 Bond Interest Expense 17,087 2 Premium on Bonds Pay. 3 Cash 18,000 4 $400,000 x 9% stated rate x 1/2 year 5 6 7 8 9 10 11

GENERAL JOURNAL Oct. 1 Bond Interest Expense Premium on Bonds Pay. DATE DESCRIPTION DEBIT PR CREDIT 1 Oct. 1 Bond Interest Expense 17,087 2 Premium on Bonds Pay. 913 3 Cash 18,000 4 $18,000 - $17,087 5 6 7 8 9 10 11

Carrying Value of Bonds PREMIUM AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 $27,181 - $913

PREMIUM AMORTIZATION $400,000 face value + $26,269 unamortized premium Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 $400,000 face value + $26,269 unamortized premium

Carrying Value of Bonds PREMIUM AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 4/1/-2 18,000 17,051 $426,269 x 4%

Carrying Value of Bonds PREMIUM AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 4/1/-2 18,000 17,051 949 $18,000 - $17,051

Carrying Value of Bonds PREMIUM AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 4/1/-2 18,000 17,051 949 25,319 $26,269 - $949

Carrying Value of Bonds PREMIUM AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 4/1/-2 18,000 17,051 949 25,319 425,319 $400,000 + $25,319

PREMIUM AMORTIZATION The amortization of the premium Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 4/1/-2 18,000 17,051 949 25,319 425,319 The amortization of the premium continues in the same manner throughout the remaining life of the bond.

Carrying Value of Bonds PREMIUM AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Premium Amortization Unamortized Premium Date 4/1/-1 $27,181 $427,181 10/1/-1 $18,000 $17,087 $ 913 26,269 426,269 4/1/-2 18,000 17,051 949 25,319 425,319 10/1/-2 18,000 17,013 987 24,332 424,332 4/1/10 18,000 16,222 1,778 3,773 403,773 10/1/10 18,000 16,151 1,849 1,924 401,924 3/31/11 18,000 16,076 1,924 400,000

DISCOUNT AMORTIZATION EXAMPLE: On April 1, 20-1 the stated rate of 9% is LESS than the current market rate of 10%, so Watkin Corp. will sell the $400,000, 10-year bonds for $375,076. FORMULA: Carrying Value x Semiannual Effective Interest rate $375,076 5% x Market Rate of 10% for 1/2 year

DISCOUNT AMORTIZATION EXAMPLE: On April 1, 20-1 the stated rate of 9% is LESS than the current market rate of 10%, so Watkin Corp. will sell the $400,000, 10-year bonds for $375,076. FORMULA: Carrying Value x Semiannual Effective Interest rate $375,076 5% x Interest Expense is $18,754

interest payment is computed GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Oct. 1 Bond Interest Expense 18,754 2 Discount on Bonds Pay. 3 4 Will be determined after Cash interest payment is computed 5 6 7 8 9 10 11

GENERAL JOURNAL Oct. 1 Bond Interest Expense Discount on Bonds Pay. DATE DESCRIPTION DEBIT PR CREDIT 1 Oct. 1 Bond Interest Expense 18,754 2 Discount on Bonds Pay. 3 Cash 18,000 4 $400,000 x 9% stated rate x 1/2 year 5 6 7 8 9 10 11

GENERAL JOURNAL Oct. 1 Bond Interest Expense Discount on Bonds Pay. DATE DESCRIPTION DEBIT PR CREDIT 1 Oct. 1 Bond Interest Expense 18,754 2 Discount on Bonds Pay. 754 3 Cash 18,000 4 $18,754 - $18,000 5 6 7 8 9 10 11

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 $24,170 - $754

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 $400,000 - $24,170

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 4/1/-2 18,000 18,791 $375,830 x 5%

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 4/1/-2 18,000 18,791 791 $18,791 - $18,000

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 4/1/-2 $18,000 $18,791 791 23,379 $24,170 - $791

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 4/1/-2 $18,000 $18,791 791 23,379 376,621 $400,000 - $23,379

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 4/1/-2 $18,000 $18,791 791 23,379 376,621 The amortization of the discount continues in the same manner throughout the remaining life of the bond.

DISCOUNT AMORTIZATION Carrying Value of Bonds Cash Payment Interest Expense Discount Amortization Unamortized Discount Date 4/1/-1 $24,924 $375,076 10/1/-1 $18,000 $18,754 $ 754 24,170 375,830 4/1/-2 18,000 18,791 791 23,379 376,621 10/1/-2 18,000 18,831 831 22,547 377,453 4/1/10 18,000 19,728 1,728 3,717 396,283 10/1/10 18,000 19,814 1,814 1,903 398,097 3/31/11 18,000 19,903 1,903 400,000

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