Chapter 10, Problem 10P

1.

To determine

Calculate the issuance price of the bonds on January 1, 2014.

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.

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

Present Value: The current value of an amount that is to be paid or received in future is called as present value.

Determine the issuance price of the bonds.

Step 1: Calculate the cash interest payment for bonds.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$700,000\times 13\%\times \frac{1}{2}\\ =\$45,500\end{array}$

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

Particulars	Amount
Interest payment (a)	$45,500
PV factor at annual market interest rate of 6% for 10 periods (b)	7.3601
Present value $\left(\text{a}\times \text{b}\right)$	$334,885

Table (1)

Note: The present value factor for 10 periods at 6% interest would be 7.36010 (Refer Appendix A (Table A.2) in the book for present value factor).

Step 3: Calculate the present value of single principal payment of $700,000 (principal amount) at 6% for 10 periods.

Particulars	Amount
Single principal payment (a)	$700,000
PV factor at annual market interest rate of 6% for 10 periods (b)	0.5584
Present value $\left(\text{a}\times \text{b}\right)$	$390,880

Table (2)

Note: The present value factor for 10 periods at 6% interest would be 0.5584 (Refer Appendix A (Table A.1) in the book for present value factor).

Step 4: Calculate the issue price of the bonds.

$\begin{array}{c}\text{Issue price of the bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of single principal payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$334,885}\left(\text{from table 1}\right)\\ +\text{\$390,880}\left(\text{from table 2}\right)\end{array}\right)\\ =\text{\$725,765}\end{array}$

Conclusion

Hence, the issuance price of the bonds on January 1, 2014 is $725,765.

2.

a.

To determine

Calculate the amount of interest expense that should be recorded on June 30, 2014.

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.

Interest Expense: The cost of debt which is occurred during a particular period of time is called interest expense. The interest amount is payable on the principal amount of debt at a fixed interest rate.

Calculate the amount of interest expense that that should be recorded on June 30, 2014.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Book value of bond }\left(\text{issue price}\right)\times \text{Market interest rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= \$725,765}\times 12\%\times \frac{1}{2}\\ =\$43,546\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on June 30, 2014 is $43,546.

b.

To determine

Calculate the amount of interest expense that should be recorded on December 31, 2014.

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.

Interest Expense: The cost of debt which is occurred during a particular period of time is called interest expense. The interest amount is payable on the principal amount of debt at a fixed interest rate.

Calculate the amount of interest expense that that should be recorded on December 31, 2014.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Book value of bond }\times \text{Market interest rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= }\left(\$725,765-\left(\$45,500-\$43,546\right)\right)\times 12\%\times \frac{1}{2}\\ =\$43,429\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on December 31, 2014 is $43,429.

3.

a.

To determine

Calculate the amount of cash that should be paid to investors on June 30, 2014.

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.

Calculate the amount of cash that should be paid to investors on June 30, 2014.

$\begin{array}{c}\text{Cash paid}=\left(\begin{array}{l}\text{Face value of bond }\times \text{coupon rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= \$700,000}\times 13\%\times \frac{1}{2}\\ =\$45,500\end{array}$

Conclusion

Hence, amount of cash that should be paid to investors on June 30, 2014 is $45,500.

b.

To determine

Calculate the amount of cash that should be paid to investors on December 31, 2014.

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.

Calculate the amount of cash that should be paid to investors on December 31, 2014.

$\begin{array}{c}\text{Cash paid}=\left(\begin{array}{l}\text{Face value of bond }\times \text{coupon rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= \$700,000}\times 13\%\times \frac{1}{2}\\ =\$45,500\end{array}$

Conclusion

Hence, amount of cash that should be paid to investors on December 31, 2014 is $45,500.

4.

a.

To determine

Calculate the book value of the bonds on June 30, 2014.

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.

Determine the book value of the bonds on June 30, 2014.

$\begin{array}{c}\text{Book value of bond on June 30 =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ -\text{Premium amortized on June 30}\end{array}\right)\\ =\left(\$725,765-\left(\$45,500-\$43,546\right)\right)\\ =\$723,811\end{array}$

Conclusion

Hence, the book value of the bonds on June 30, 2014 is $723,811.

b.

To determine

Calculate the book value of the bonds on December 31, 2014.

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.

Determine the book value of the bonds on December 31, 2014.

$\begin{array}{c}\text{Book value of bond on December 31 =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ -\text{Premium amortized on June 30}\\ -\text{Premium amortized on December 31}\end{array}\right)\\ =\left(\begin{array}{l}\$725,765-\left(\$45,500-\$43,546\right)\\ -\left(\$45,500-\$43,429\right)\end{array}\right)\\ =\$721,740\end{array}$

Conclusion

Hence, the book value of the bonds on December 31, 2014 is $721,740.