Chapter 10, Problem 10.7P

Recording and Reporting a Bond Issued at a Discount (with Discount Account) (AP10-4)

LO10-4 Claire Corporation is planning to issue bonds with a face value of $100,000 and a coupon rate of 8 percent. The bonds mature in two years and pay interest quarterly every March 31, June 30, September 30, and December 31. All of the bonds were sold on January 1 of this year. Claire uses the    effective-interest amortization method and also uses a discount account. Assume an annual market rate of interest of 12 percent.

Required:

1. 1. Provide the journal entry to record the issuance of the bonds.
2. 2. Provide the journal entry to record the interest payment on March 31, June 30, September 30, and December 31 of this year.
3. 3. What bonds payable amount will Claire report on this year’s December 31 balance sheet?

To determine

Prepare journal entry to record the sale of the bonds on January 1.

Explanation of Solution

Bonds: Bonds are long-term promissory notes that are issued by a company while borrowing money from investors to raise fund for financing the operations.

Bonds Payable: Bonds payable are referred to long-term debts of the business, issued to various lenders known as bondholders, generally in multiples of $1,000 per bond, to raise fund for financing the operations.

Bond Discount: It occurs when the bonds are issued at a low price than the face value.

Effective-interest amortization method: Effective-interest amortization method is an amortization model that apportions the amount of bond discount or premium based on the market interest rate.

Prepare journal entry for the sale of the bonds on January 1.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
January 1		Cash (1)				92,980
		Bond Discount (2)				7,020
			Bonds Payable				100,000
				(To record issuance of bonds payable at discount)

Table (1)

• Cash is an asset and it is increased. So, debit it by $92,980.
• Bond Discount is an adjunct liability account and it is decreased. So, debit it by $7,020.
• Bonds payable is a liability and it is increased. So, credit it by $100,000.

Working notes:

Determine the issuance price of the bonds.

Step 1: Calculate the cash interest payment for bonds.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$100,000\times 8\%\times \frac{3}{12}\\ =\$2,000\end{array}$

Step 2: Calculate the present value of cash interest payment.

Particulars	Amount
Interest payment (a)	$2,000
PV factor at annual market interest rate of 3% for 8 periods (b)	7.01969
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$14,039

Table (2)

Note: The present value factor for 8 periods at 3% interest would be 7.01969 (Refer Appendix E (Table E.2) in the book for present value factor).

Step 3: Calculate the present value of single principal payment of $100,000 (principal amount) at 3% for 8 periods.

Particulars	Amount
Single principal payment (a)	$100,000
PV factor at annual market interest rate of 3% for 8 periods (b)	0.78941
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$78,941

Table (3)

Note: The present value factor for 8 periods at 3% interest would be 0.78941 (Refer Appendix E (Table E.1) in the book for present value factor).

Step 4: Calculate the issue price of the bonds.

$\begin{array}{c}\text{Issue price of the bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of single principal payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$14,039}\left(\text{from table 1}\right)\\ +\text{\$78,941}\left(\text{from table 2}\right)\end{array}\right)\\ =\text{\$92,980}\end{array}$ (1)

Calculate the amount of bond discount.

$\begin{array}{c}\text{Bond discount = }\left(\begin{array}{l}\text{Face value }\\ -\text{ Cash received}\end{array}\right)\\ =\$100,000-\$92,980\\ =\$7,020\end{array}$ (2)

To determine

Prepare journal entry to record payment of interest on March 31.

Explanation of Solution

Prepare journal entry for payment of interest on March 31.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
March 31		Interest Expense (4)				2,789
			Bond Discount (5)				789
			Cash (3)				2,000
				(To record payment of interest)

Table (4)

• Interest expense is an expense and it decreases the equity value. So, debit it by $2,789.
• Bond discount is an adjunct liability account and it is increased. So, credit it by $789.
• Cash is an asset and it is decreased. So, credit it by $2,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$100,000\times 8\%\times \frac{3}{12}\\ =\$2,000\end{array}$ (3)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\$92,980\times 12\%\times \frac{3}{12}\\ =\$2,789\end{array}$ (4)

Calculate bond discount.

$\begin{array}{c}\text{Bond discount}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$2,789-\$2,000\\ =\$789\end{array}$ (5)

To determine

Prepare journal entry to record payment of interest on June 30.

Explanation of Solution

Prepare journal entry for payment of interest on June 30.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
June 30		Interest Expense (7)				2,813
			Bond Discount (8)				813
			Cash (6)				2,000
				(To record payment of interest)

Table (5)

• Interest expense is an expense and it decreases the equity value. So, debit it by $2,813.
• Bond discount is an adjunct liability account and it is increased. So, credit it by $813.
• Cash is an asset and it is decreased. So, credit it by $2,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$100,000\times 8\%\times \frac{3}{12}\\ =\$2,000\end{array}$ (6)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\left(\$92,980+\$789\right)\times 12\%\times \frac{3}{12}\\ =\$2,813\end{array}$ (7)

Calculate bond discount.

$\begin{array}{c}\text{Bond discount}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$2,813-\$2,000\\ =\$813\end{array}$ (8)

To determine

Prepare journal entry to record payment of interest on September 30.

Explanation of Solution

Prepare journal entry for payment of interest on September 30.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
September 30		Interest Expense (10)				2,837
			Bond Discount (11)				837
			Cash (9)				2,000
				(To record payment of interest)

Table (6)

• Interest expense is an expense and it decreases the equity value. So, debit it by $2,837.
• Bond discount is an adjunct liability account and it is increased. So, credit it by $837.
• Cash is an asset and it is decreased. So, credit it by $2,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$100,000\times 8\%\times \frac{3}{12}\\ =\$2,000\end{array}$ (9)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\left(\$92,980+\$789+\$813\right)\times 12\%\times \frac{3}{12}\\ =\$2,837\end{array}$ (10)

Calculate bond discount.

$\begin{array}{c}\text{Bond discount}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$2,837-\$2,000\\ =\$837\end{array}$ (11)

To determine

Prepare journal entry to record payment of interest on December 31.

Explanation of Solution

Prepare journal entry for payment of interest on December 31.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31		Interest Expense (13)				2,863
			Bond Discount (14)				863
			Cash (12)				2,000
				(To record payment of interest)

Table (7)

• Interest expense is an expense and it decreases the equity value. So, debit it by $2,863.
• Bond discount is an adjunct liability account and it is increased. So, credit it by $863.
• Cash is an asset and it is decreased. So, credit it by $2,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$100,000\times 8\%\times \frac{3}{12}\\ =\$2,000\end{array}$ (12)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\left(\$92,980+\$789+\$813+\$837\right)\times 12\%\times \frac{3}{12}\\ =\$2,863\end{array}$ (13)

Calculate bond discount.

$\begin{array}{c}\text{Bond discount}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$2,863-\$2,000\\ =\$863\end{array}$ (14)

To determine

Show the presentation of bonds payable that would be reported on December 31 balance sheet.

Explanation of Solution

Bonds Payable: Bonds payable are referred to long-term debts of the business, issued to various lenders known as bondholders, generally in multiples of $1,000 per bond, to raise fund for financing the operations.

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources, on a specific date. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

The presentation of bonds payable that would be reported on December 31 balance sheet is as shown below:

Corporation C Balance Sheet (Partial) As of December 31
Long-term Liabilities:
Bonds Payable (15)	$96,282

Table (8)

Working note:

Calculate the amount of bonds payable on December 31.

$\begin{array}{c}\text{Bonds payable on December 31 =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ \text{+}\text{Discount amortized on March 31}\\ \text{+}\text{Discount amortized on June 30}\\ \text{+}\text{Discount amortized on September 30}\\ \text{+}\text{Discount amortized on December 31}\end{array}\right)\\ =\left(\$92,980+\$789+\$813+\$837+\$863\right)\\ =\$96,282\end{array}$ (15)