Example Exercise 3 Amortizing a Bond Discount A bond discount must be amortized to interest expense over the life of the bond. A bond discount must be amortized to interest expense over the life of the bond. The entry to amortize a bond discount [CLICK] includes a debit to Interest Expense and a credit to Discount on Bonds Payable. The entry could be combined with the semiannual interest payment [CLICK] by debiting Interest Expense, crediting Discount on Bonds Payable and crediting Cash for the amount of the semiannual interest. The entry could be combined with the semiannual interest payment as follows: Cash (amount of semiannual interest) XXX

Example Exercise 3 Amortizing a Bond Discount The two methods of computing the amortization of a bond discount are: Straight-line method Effective interest rate method The two methods of computing the amortization of a bond discount are [CLICK] the straight-line method [CLICK] and the effective interest rate method. The effective interest rate method is required by GAAP, [CLICK] however, the straight-line method may be used if the results do not differ significantly. Required by GAAP

Example Exercise 3 Amortizing a Bond Discount Recall that on January 1, 2011, Western Wyoming Distribution Inc. issued the following bonds: In the previous example exercise, we discussed Western Wyoming Distribution. Recall that they issued bonds with a face amount of $100,000, a contract rate of 12% and a market rate of 13%. They received proceeds of $96,406 resulting in a discount of $3,594. Using the straight-line method of amortizing discount, the amortization is $359.40 for each of ten periods. Ten periods is used because the interest is paid semiannually [CLICK] for 5 years. Discount ($100,000 – $96,406) $3,594.00 Number of semi-annual periods in 5 years 10 Discount amortization per period $ 359.40

Example Exercise 3 Amortizing a Bond Discount The journal entry to record the first interest payment and the amortization of the discount would include a debit to Interest Expense for $6,359.40, a credit to Discount on Bonds Payable for $359.40 and a credit to Cash for $6,000. The semiannual contract rate of interest is determined by dividing the annual rate of interest by 2. [CLICK] The cash interest paid is $100,000 times 6%, or $6,000. Interest expense is cash interest plus the discount of $359.40 to get $6,359.40 [CLICK]. Face amount of bond $100,000.00 Semiannual interest rate 6% Cash paid at each interest date $ 6,000.00 Discount on bonds payable 359.40 Interest expense $ 6,359.40

Example Exercise 3 3 Discount ($1,000,000 – $936,420) $63,580 Number of periods 10 Discount amortization per period $ 6,358 Let’s look at the example exercise. Using the bond from the previous example exercise, shown here, [CLICK] we’ll journalize the first interest payment and the amortization of the bond discount. First we need to determine the discount amortization. The discount is $63,580 determined by subtracting the proceeds of $936,420 from the face amount of the bond of $1 million. [CLICK] Using the straight-line method of amortizing the discount, the amortization is $6,358 for each of ten periods. [CLICK]

Example Exercise 3 3 Face amount of bond $1,000,000 The entry would include [CLICK] a debit to Interest Expense for $36,358, a credit to Discount on Bonds Payable for $6,358 and a credit to Cash for $30,000. The semiannual contract rate of interest is determined by dividing the annual rate of interest by 2. [CLICK] The cash interest paid is $1,000,000 times 36% or $30,000. Interest expense is cash interest plus the discount of $6,358 to get $36,358 Face amount of bond $1,000,000 Semiannual interest rate 3% Cash paid at each interest date $ 30,000 Discount on bonds payable 6,358 Interest expense $ 36,358

Example Exercise 3 3  For Practice: PE 3A, PE 3B 3A, 3B Refer to Practice Exercises PE 3A and PE 3B to practice on entries recording discount amortization.  For Practice: PE 3A, PE 3B