Chapter 10, Problem 10.7PB

(Supplement 10B) Recording Bond Issue, Interest Payments (Effective-Interest Amortization), and Early Bond Retirement

Refer to PB 10-6. Assume Methodical uses the effective-interest bond amortization method.

Required:

1. 1. Prepare a bond amortization schedule.
2. 2. Give the journal entry to record the bond issue.
3. 3. Give the journal entries to record the interest payments on December 31, 2015 and 2016.
4. 4. Give the journal entry to record the interest and face value payment on December 31, 2017.
5. 5. Assume the bonds are retired on January 1, 2017, at a price of 101. Give the journal entry to record the bond retirement.

To determine

To prepare: Abond amortization schedule.

Explanation of Solution

Amortization Schedule: An amortization schedule is a table that shows the details of each loan payment allocated between the principal amount and the overdue interest along with the beginning and ending balance of the loan. From the amortization schedule of the loan, the periodical interest expense, total interest expense and total payment made are known.

Prepare bond amortization schedule as below:

Bond premium amortization schedule – Effective-interest amortization method
Year Ending December 31	Cash Paid (A)	Interest Expense (B)	Premium Amortized (C) = (A-B)	Bonds Payable (D)	Premium on Bonds Payable (E)	Carrying Value (F) =(D+E)
01/01/15	–	–	–	$100,000	$2,070	$102,070
12/31/15	$5,000	$4,338	$662	$100,000	$1,408	$101,408
12/31/16	$5,000	$4,310	$690	$100,000	$718	$100,718
12/31/17	$5,000	$4,282 (rounded)	$718	$100,000	0	$100,000

Table (1)

Working notes:

Calculate premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = }\left(\begin{array}{l}\text{Cash received}\\ -\text{Face value }\end{array}\right)\\ =\$102,070-\$100,000\\ =\$2,070\end{array}$

Calculate the amount of cash paid.

$\begin{array}{c}\text{ Cash paid = }\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$100,000\times 5\%\times 1\\ =\$5,000\end{array}$

Premium on bonds payable for each period is calculated by the following formula:

$\text{Premium on bonds payable = Previous balance of premium on bonds payable - Premium amortized}$

To determine

To prepare: Journal entry to record the issuance of the bonds on January 1, 2015.

Explanation of Solution

Bonds: Bonds are long-term promissory notes that are represented 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.

Premium on bonds payable: It occurs when the bonds are issued at a higherprice than the face value.

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

Prepare journal entry for cash proceeds from the issuance of the bonds on January 1, 2015.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
January 1, 2015		Cash				102,070
			Premium on Bonds Payable				2,070
			Bonds Payable				100,000
				(To record issuance of bonds payable at discount)

Table (2)

• Cash is an asset and it is increased. So, debit it by $102,070.
• Premium on Bonds Payable is an adjunct liability account and itis increased. So, creditit by $2,070.
• Bonds payable is a liability and it is increased. So, credit it by $100,000.

Working note:

Calculate premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = }\left(\begin{array}{l}\text{Cash received}\\ -\text{Face value }\end{array}\right)\\ =\$102,070-\$100,000\\ =\$2,070\end{array}$

To determine

To prepare: Journal entry to record the interest payment on December 31, 2015.

Explanation of Solution

Prepare journal entry for payment of interest and amortization of premium on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31, 2015		Interest Expense				4,338
		Premium on Bonds Payable				662
			Cash				5,000
				(To record payment of interest and amortization of premium on bonds)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $4,338.
• Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $662.
• Cash is an asset and it is decreased. So, credit it by $5,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$100,000\times 5\%\times 1\\ =\$5,000\end{array}$

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\$102,070\times 4.25\%\times 1\\ =\$4,338\end{array}$

Calculate premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000-\$4,338\\ =\$662\end{array}$

To determine

To prepare: Journal entry to record the interest payment on December 31, 2016.

Explanation of Solution

Prepare journal entry for payment of interest and amortization of premium on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31, 2016		Interest Expense				4,310
		Premium on Bonds Payable				690
			Cash				5,000
				(To record payment of interest and amortization of premium on bonds)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $4,310.
• Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $690.
• Cash is an asset and it is decreased. So, credit it by $5,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$100,000\times 5\%\times 1\\ =\$5,000\end{array}$

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$102,070-\$662\right)\times 4.25\%\times 1\\ =\$4,310\end{array}$

Calculate premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000-\$4,310\\ =\$690\end{array}$

To determine

To prepare: Journal entry to record the interest and face value payment on December 31, 2017.

Explanation of Solution

Prepare journal entry for payment of interest and face value.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31, 2017		Interest Expense				4,282
		Bonds Payable				100,000
		Premium on Bonds Payable				718
			Cash				105,000
				(To record payment of interest and face value)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $4,282.
• Bonds payable is a liability and it is decreased. So, debit it by $100,000.
• Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $718.
• Cash is an asset and it is decreased. So, credit it by $105,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$100,000\times 5\%\times 1\\ =\$5,000\end{array}$

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$102,070-\$662-\$690\right)\times 4.25\%\times 1\\ =\$4,282\end{array}$

Calculate premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000-\$4,282\\ =\$718\end{array}$

To determine

To prepare: Journal entry to record the bond retirement on January 1, 2017.

Explanation of Solution

Retirement of Bonds: The process of repaying the sale amount of bonds to bondholders at the time of maturity or before the maturity period is called as retirement of bonds. It is otherwise called as redemption of bonds.

Prepare Journal entry to record the bond retirement on January 1, 2017.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
January 1, 2017		Bonds Payable				100,000
		Premium on Bonds Payable				718
		Loss on Retirement of Bonds				282
			Cash				101,000
				(To record the retirement of the bonds)

• Bonds payable is a liability and it is decreased. So, debit it by $100,000.
• Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $718.
• Loss on retirement of bonds is an equity account and it is decreased. So, debit it by $282.
• Cash is an asset and it is decreased. So, credit it by $101,000

Working note:

Determine the gain or loss on the retirement of the bonds.

Step 1: Calculate carrying amount of bonds payable on the retirement.

$\begin{array}{c}\text{ Carrying amount of bonds payable = }\left(\begin{array}{l}\text{Face value }\\ \text{+Unamortized premium }\end{array}\right)\\ =\$100,000+\$718\\ =\$100,718\end{array}$

Step 2: Compute loss on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Loss on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Cash paid to retire }\\ \text{the bonds}\end{array}\right)-\left(\begin{array}{l}\text{Carrying amount }\\ \text{of bonds payable}\end{array}\right)\\ =\left(\$100,000\times 101\%\right)-\$100,718\\ =\$101,000-\$100,718\\ =\$282\end{array}$