In this lesson, we're going to start with a very simple example of a bond so that you get to see the basic principles and then gradually we will be adding more complexity with additional features like a discount or a premium or conversion feature or having it issued between dates. Well, we'll build upon this simple structure that we start with right now just to give you the basics of bond accounting. Again, this is ignoring a lot of other costs and complicating factors, but it's a good place to start. So, let's take an example. January 1st, 2017, Padre Pizza issues $10 million of bonds at 6 percent. So, 10 million is the face amount or the par value of the bonds. Six percent is the stated interest rate. Since there's no discount or premium, that's also the effective interest rate. The interest rate will be payable semiannually. That's twice a year on June 30th and December 31st for 10 million. Notice we had issued on January 1st, 2017 to make the math easier. In my experience, not a lot of bonds are actually issued on January 1st for some reason, it's a holiday. But again, you'll see this a lot in accounting problems. So, what is the interests that will be paid semiannually. So, how much is the semiannual interest? While the interests that will be due on June 30th and December 31st is going to be my stated interest rate of six percent, we can adjust it for the fact that it's only half a year. Here, I'm using the 360 day convention, I've got a 180 divided by 360. You could also just divide it by two. But it's six percent or six percent times one-half a year, times the carrying amount, which in this case is equal to the par value of 10 million, and I would have $300,000 of interest payable every six months. Here's what we'll do with those amounts we just calculated. Now, an issuance we're going to record the receipt of cash and the issuance of bonds, bonds payable, no discount, no premium, no initial costs, strictly at par, $10 million. So, remember this program was structured to be simple, it's not realistic. But sometimes, this is what you'll see in accounting problems. So, what will the interest payments look like? Let's do it under two scenarios, one in which you're preparing interim statements and one and which are not preparing interim financial statements. Let's start with the no interim financial statements first. On June 30th, I will debit my interest expense for 300,000 and credit cash. There's my interest. Well, what if we're issuing interim financial statements, that means at March 31st, I'm going to have accrued interest. Well, that's going to look like this, March 31st, I'll debit interest expense for half of the amount. Why? Because it's three months of the six months. Of a 150,000 and the interest payable for a 150,000, and then June 30th when I get to the second quarter, I'll have interest expense for that quarter of an interest payable from the previous quarter and pay the cash of 300,000 out. Note that the payments are for interest only. This type of bond pays interest during the term of the bonds and the principal is paid in a lump sum at maturity. So, what happens when we get to the end of the term of the bonds and I pay him back? Well, I debit bonds payable for $10 million. I will credit cash for $10 million. So, let's go to Excel and we'll do just a little variation. This will change it just a little bit. What we're going to do is we're going to change the interest rate to eight percent, but we're going to include a premium where the bonds are issued for $10,200,000. Well, let's just see how that changes the entries. In this segment, we're going to put together a bond amortization schedule, and it's a little bit more complicated than the spreadsheet that we did in our first module where we were making an accrual for a current liability. But I think you'll find the skills that you'll learn to put this together to be useful in a wide variety of applications. So, let's take a look at what we've got. Our problem is Padre Pizza. They've issued bonds at $10 million worth of bonds at January 1st, 2016 that mature in eight years on 12/31/2023. Now, they pay interest semiannually a very common occurrence. Usually that bonds pay interest either quarterly or semiannually. They have a stated interest rate of eight percent. But they were sold for $10,200,000. So, where the bonds sold at a discount or premium? Well, you got more than the stated amount of the bonds, that's a premium. So, let's put together a little data table again just like we did for the current liability to put on our variables in it. So, let's start by entering the principle over here and the principal is $10 million. So, this is the stated amount on the bonds. Sometimes it's referred to as the par value. The number of periods. Well, it's eight years, but the bonds are issued as pay interest semiannually. So, you would have two periods a year. So, the number of periods is going to be 16. It's a number of years times you pay interest during the course of the year. Then the rate that we have well, the standard rate of the bonds is eight percent. So, we'll put that in here. That means that the semiannual interest and we'd already put it in a little formula to multiply that is going to be $400,000. That's how much cash is going to be paid twice a year by the issuer of the bonds to the lucky person that's holding the bonds. So, the carrying value we're going to calculate now. As we pointed out in our slides, it's going to be a present value calculation. So, let's go over here and we're going to calculate the present value. Let's do it of the interest first. So, the present value of the interest. Let's use the present value function within Excel. So, that's equal PV, and you can see that you need to enter in the rate, number of periods of payment, and the fair value. So, the rate is going to be eight percent. Let's point to the effective rate here, but divided by two because it's paid semiannually or you could do 180 over 360, it's the same equivalent, times 180 over 360. Then the number of periods is going to be 16. So, it's point to here to the periods. Then the payment is going to be 400,000 the amount of interests that we just calculated is going to be paid and then we're done. So, let's close that. We have a present value of $4,660,000. Now, Excel looks at this from the point of view of an investor. So, it came back with a negative number, we want to deal with a positive number. So, let's go back in and put a negative sign in front of the number of the payments because they're actually being payments out. So, that gives us a present value for the interest portion of what we're going to pay in the bonds of $4,660,000. Now, let's do the same thing for the principal because at the end of the 16th period, you not only get the $400,000 if you're the investor, you also get your $10 million back if you're the issuer at the end of the 16th period. You not only have to pay $400,000 of interest payments in cash, you also have to pay back the principal. So, that's going to be the present value calculation again. So, let's use PV. Again, the rate is going to be our effective rate divided by two. The number of periods is still 16. Now, the payment this time is zero, because there is not a series of payments that are going on. So, this is a difference between having the interest rate which is a series of payments, you enter them in the payment or trying to get the amount at the end of the period. So, we've got zero there for the payment, but now that future value is going to be $10 million. So, we'll point to the principal up here. That's it, we can close that out. I'm sorry, we should have done negative in front of the 10 million. So, let's go back and fix that. What we've got now, go ahead and click Enter, is you can see that the present value of the principal and the interest is $10 million. Now, that's a great way to see that you've done the equations right, because, well, right now, we're using the eight percent, which is the stated value. In a bond issue, the present value of the bond should always be equal to the stated amount of the bonds when you're using the stated interest rate. But what happens here is that we didn't have an amount equal to $10 million in issuance. Instead, we had premium. The investors were willing to pay us more for these bonds. That means that market interest rates must have been less than eight percent because the market is willing to pay us a premium. So, how do we calculate the effective interest rate when the bonds were issued at a premium? Well, one way we can do that is to use a function in Excel called Goal Seek. That's really cool. You'll find that in data up here. So, if we go over to data, and we go over to what-if analysis, then we can select Goal Seek. Now we've got the cursor on a cell that's blank right now. So, it's going to say, "What do you want to do?" Well, we want this cell right here to be 10,200,000. So, we want to click on this cell, that, that one, that one, and we want to put it at a value of 10,200,000. You can't put a formula in the cell, unfortunately, and that'll be by changing the cell up here with the effective rate. So, click on that and hit Okay. It does its magic. It comes back and tells you that the effective rate on this with the premium is actually 7.66 percent. So, now we've got the carrying value of the bonds at 10,200,000. Let's put that in here. We know that the premium on the bonds is going to be 10,200,000 minus 10 million or $200,000. That is the premium on the bonds. So, now, we've already done an amortization table for you. We're going to show it to you right now and see how this works out through the course of the month. We're going to start with our carrying value here at the top, right? I'm going to go back to inking again. So, we've brought our carrying value down and put it here. The payment, here's our stream of payments, is $400,000 for all 16 periods. Then, at maturity, we're having the $10 million payment. So, the net carrying value at the end will be zero. In the meantime, we have $200,000 of premium to amortize. We're going to do that according to GAP using the effective rate. So, what we do, each period is we take the carrying value and multiply it times the effective rate, and you can see how that works. If you go on interest, there's a cool feature also in Excel called C Precedence. So, let's go back to that. I think it's in formulas. You can click on that and Trace Precedence. Let's do the precedence for the interest. Trace Precedence. You can see that it's our effective rate times the carrying value. If you go down to the next line and do the same thing, you'll see it's just the new carrying value, again, times that effective rate. So, let's clear off our arrows and go back. This will go all the way down. Now, you know you've done this right. This is another self check. If you get to the end of the amortization table, if you get to the end, let's go back to review and start inking. Sorry. If you get down to the bottom and this amount equals your face amount, this is another self check. I've done it right. I've calculated the proper effective yield. This is the effective interest method. It's required by GAP. The fact we have a premium means that the effective rate is going to be different from the stated rate. I know it's going to be lower because when there's a premium, the market rates must be lower than the stated amount on the bonds. So, let's go back and look. What do I do now that I've got all this wonderful information? I can prepare my journal entries. My first interest payments is going to take this interest rate from the top of the amortization schedule, and that's going to be my interest expense. The amortization here is a difference between the amount that I paid and my effective interest rate. It's the difference between the two. There we go. I would need that amount to make this journal entry balance in any event, and here's my cash paid. So, there's my payment for the first period. Each period, I will just take those amounts the same way. When I get down to the end, here's my interest payment for the final payment. Notice the interest rate has gone down because this is a case of the interest is front-loaded into the earlier years of a bond payment, right? Because the balance that I'm amortizing on is larger, and it's declining down to 10 million, it'll go the opposite direction. If I have a discount, by the way, it'll be increasing over time, as opposed to decreasing. Here's my amortization in the final period, and there's my cash amount, which is constant, of course, throughout the time of the loan. Then bonds payable and cash. I pay of the bonds. I'm done. So, this is a simple table. It shows you, though, a couple of different really important things. One, how to calculate an effective rate of interest, how to document your bond payments. Your auditors will be grateful. You will be grateful if you need to go back and change it. We should be able to enter in revised rates here and change this bond. You'll be able to use this tool. If you ever worked on a bond issue, things change daily, almost. The amount that's going to be issued for the effective interest rate changes. This sort of tool will help you keep on top of the financial implications of a bond issue all throughout the process. So, this is the simplest type of bond entry. You should be very comfortable with what's going on in this because it gets more complicated from this point forward. Thank you.