Chapter 10, Problem 10AP

a.

To determine

Prepare an amortization schedule

Explanation of Solution

Amortization of bond: The process of allocation and reduction of the discount or premium on bonds to interest expense over the life of bonds is referred to as amortization of bonds.

Effective interest method: The process of amortization that uses fixed interest rate (effective interest rate) to amortize the premium or discount on bonds is known to as effective interest method of amortization.

The effective amortization table for first two interest periods, showing the amortization of discount is prepared as follows:

Bonds Payable-Premium Amortization Table

(Effective Interest Method)

	Interest Paid	Interest Expense	Periodic Premium Amortized	Balance of Unamortized Premium	Ending Book Value
01/01/20XX				$158,342	$958,342
30/06/20XX	$40,000 (1)	$38,342 (2)	$1,666 (3)	$156,676	$956,676 (4)
12/31/20XX	$40,000 (1)	$38,267 (5)	$1,733 (6)	$154,943	$954,943 (7)

Table (1)

Working Notes:

Calculate interest paid on June 30 (first interest period).

$\begin{array}{c}\text{Interest paid}=\left(\begin{array}{l}\text{Face value of bonds}\times \text{Face interest rate}\\ \times \text{Semiannual interest time period}\end{array}\right)\\ =\$800,000\times \frac{10}{100}\times \frac{6}{12}\\ =\$40,000\end{array}$ (1)

Calculate interest expense on June 30 (first interest period).

$\begin{array}{c}\text{Interest expense }=\left(\begin{array}{l}\text{Ending book value }\times \text{ Effective interest rate}\\ \times \text{Semiannual interest time period}\end{array}\right)\\ =\$958,342\times \frac{8}{100}\times \frac{6}{12}\\ =\$38,334\end{array}$ (2)

Calculate premium amortized on June 30 (first interest period).

$\begin{array}{c}\text{Premium amortized }=\text{ Interest paid }-\text{Interest expense}\\ =\$40,000-\$38,334(2)\\ =\$1,666\end{array}$ (3)

Calculate ending book value on June 30 (first interest period).

$\begin{array}{c}\begin{array}{l}\text{Ending book value }\\ \text{on June 30}\end{array}\}=\left\{\begin{array}{l}\text{Ending book value on December 31}\\ -\text{ Premium amortized}\end{array}\right\}\\ =\$958,342-\$1,666(3)\\ =\$956,676\end{array}$ (4)

Calculate interest expense on December 31 (second interest period).

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Ending book value}\\ \times \text{Effective interest rate}\\ \times \text{Semiannual interest time period}\end{array}\right)\\ =\$956,676(4)\times \frac{8}{100}\times \frac{6}{12}\\ =\$38,267\end{array}$ (5)

Calculate premium amortized on December 31 (second interest period).

$\begin{array}{c}\text{Premium amortized }=\text{ Interest paid }-\text{ Interest expense }\\ =\$40,000(1)-\$38,267(5)\\ =\$1,733\end{array}$ (6)

Calculate ending book value on December 31 (second interest period).

$\begin{array}{c}\begin{array}{l}\text{Ending book value }\\ \text{on June 30}\end{array}\}=\left\{\begin{array}{l}\text{Ending book value on December 31}\\ -\text{ Premium amortized}\end{array}\right\}\\ =\$956,676–\$1,733(6)\\ =\$954,943\end{array}$ (7)

b.

To determine

Journalize the entry for the issuance of bonds on December 31.

Explanation of Solution

Prepare journal entry:

Date		Accounts and Explanations	Debit ($)	Credit ($)
December	31	Cash (A+)	958,342
		Premium on Bonds Payable (L+) (8)		158,342
		Bonds Payable (L+)		800,000
		(To record issue of bonds at premium)

Table (2)

• Cash is an asset account and it is increased. Therefore debit cash account by $958,342.
• Premium on Bonds Payable is an adjunct-liability account and it has a normal credit balance therefore, debit Premium on Bonds Payable account by $158,342.
• Bonds Payable is a liability and it is increased. Therefore credit bonds payable account by $800,000.

Working Notes:

Calculate discount on bonds payable.

$\begin{array}{c}\text{Premium }=\text{ Cash received }-\text{ Face value of bonds}\\ =\$958,342-\$800,000\\ =\$158,342\end{array}$ (8)

c.

To determine

Journalize the payment of interest and discount amortization on June 30.

Explanation of Solution

Prepare journal entry:

Date		Accounts and Explanations	Debit ($)	Credit ($)
June	30	Bond Interest Expense (E–)	38,334
		Premium on Bonds Payable (L–)	1,666
		Cash (A–)		40,000
		(To record the payment of interest and amortization of premium)

Table (3)

• Bond Interest Expense is a component of stockholders’ equity and there is a increase in the interest expense account which decreased the stockholders’ equity. Therefore debit bond interest expense account by $38,334.
• Premium on Bonds payable is an adjunct-liability account. The amount has decreased because the premium is amortized; therefore, debit Premium on Bonds Payable account by $1,666.
• Cash is an asset and it is decreased. Therefore credit cash account by $40,000.

Note: Refer to requirement (a) for the values and calculations.

d.

To determine

Journalize the entry to record the payment of interest and discount amortization on December 31.

Explanation of Solution

Prepare journal entry:

Date		Accounts and Explanations	Debit ($)	Credit ($)
December	31	Bond Interest Expense (E–)	38,267
		Premium on Bonds Payable (L–)	1,733
		Cash (A–)		40,000
		(To record the payment of interest and amortization of premium)

Table (4)

• Bond Interest Expense is a component of stockholders’ equity and there is a increase in the interest expense account which decreased the stockholders’ equity. Therefore debit bond interest expense account by $38,267.
• Premium on Bonds payable is an adjunct-liability account. The amount has decreased because the premium is amortized; therefore, debit Premium on Bonds Payable account by $1,733.
• Cash is an asset and it is decreased. Therefore credit cash account by $40,000.

Note: Refer to requirement (a) for the values and calculations.