6: A.1. Operating Activities, the Indirect Method

Question 1

when you as a company issue a bond at premium, how you reflect, the amortization on premiom on the cash flow statement?

Answer 1

We subtract it from the operating activities,

because when we sell bond at premium that mean we have more money than the face value, this amount of money will be amortize across the years, that will make the interest expense less in the income statement, lets say the bond is 1,050,000, you have 50,000 and you will amortize this amount across 5 years, that mean 10,000 every year, and the interest is 5% that mean you will pay 50,000 every year

Dr. interest expense 40,000
Dr. premium on bond payable 10,000
Cr. cash 50,000

It’s easy, notice here we have interest expense only 40,000, but we actually pay 50,000, so the income statement will be (40,000) if it’s the only transaction, so we have to decrease the premium on the bond because it decreases the expense that we actually pay to the investor

Question 2

When we have a premium on the bond payable increases from year to year, does that mean what on the cash flow statement?

Answer 2

We decreased in the operating activities

Question 3

From where will you know if the company amortizes more premium?

Answer 3

We have to look at the liability section and compare the two years. When new see the number decreasing, that means more amortization spend, we need to subtract it from the operating section

Question 4

What happens if the bond’s discount decreases from year to year? What does it reflect on the cash flow statement?

Answer 4

We increase the operating section on the balance sheet,

let’s assume we have 1,000,000 face value and we sell it for 950,000
And the interest is 10% which means 100,000, we make 110,000 (100,000 interest and 10,000 because we amortize the discount), but in real life we just pay 100,000 cas,h the other 10,000 is just amortization, so we have to increase it in the cash flow because it’s not a cash outflow