Chapter 10, Problem 11P

1.

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 Premium: It occurs when the bonds are issued at a high 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)				321,976
			Bond Premium (2)				21,976
			Bonds Payable				300,000
				(To record issuance of bonds payable at premium)

Table (1)

• Cash is an asset and it is increased. So, debit it by $321,976.
• Bond Premium is an adjunct liability account and it is increased. So, credit it by $21,976.
• Bonds payable is a liability and it is increased. So, credit it by $300,000.

Working notes:

Determine the issuance price of the bonds.

Step 1: Calculate the cash interest payment for bonds.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$300,000\times 12\%\times \frac{3}{12}\\ =\$9,000\end{array}$

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

Particulars	Amount
Interest payment (a)	$9,000
PV factor at annual market interest rate of 2% for 8 periods (b)	7.32548
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$65,929

Table (2)

Note: The present value factor for 8 periods at 2% interest would be 7.32548 (Refer Appendix E (Table E.2) in the book for present value factor).

Step 3: Calculate the present value of single principal payment of $300,000 (principal amount) at 2% for 8 periods.

Particulars	Amount
Single principal payment (a)	$300,000
PV factor at annual market interest rate of 2% for 8 periods (b)	0.85349
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$256,047

Table (3)

Note: The present value factor for 8 periods at 2% interest would be 0.85349 (Refer Appendix E (Table E.1) in the book for present value factor).

Step 4: Calculate the issue price of the bonds.

$\begin{array}{c}\text{Issue price of the bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of single principal payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$65,929}\left(\text{from table 1}\right)\\ +\text{\$256,047}\left(\text{from table 2}\right)\end{array}\right)\\ =\text{\$321,976}\end{array}$ (1)

Calculate the amount of bond premium.

$\begin{array}{c}\text{Bond premium = }\left(\begin{array}{l}\text{Cash received}\\ -\text{Face value }\end{array}\right)\\ =\$321,976-\$300,000\\ =\$21,976\end{array}$ (2)

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)				6,440
		Bond Premium (5)				2,560
			Cash (3)				9,000
				(To record payment of interest)

Table (4)

• Interest expense is an expense and it decreases the equity value. So, debit it by $6,440.
• Bond premium is an adjunct liability account and it is decreased. So, debit it by $2,560.
• Cash is an asset and it is decreased. So, credit it by $9,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$300,000\times 12\%\times \frac{3}{12}\\ =\$9,000\end{array}$ (3)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\$321,976\times 8\%\times \frac{3}{12}\\ =\$6,440\end{array}$ (4)

Calculate bond premium.

$\begin{array}{c}\text{Bond premium}=\text{Cash interest payment}-\text{Interest Expense }\\ =\$9,000-\$6,440\\ =\$2,560\end{array}$ (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)				6,388
		Bond Premium (8)				2,612
			Cash (6)				9,000
				(To record payment of interest)

Table (5)

• Interest expense is an expense and it decreases the equity value. So, debit it by $6,388.
• Bond premium is an adjunct liability account and it is decreased. So, debit it by $2,612.
• Cash is an asset and it is decreased. So, credit it by $9,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$300,000\times 12\%\times \frac{3}{12}\\ =\$9,000\end{array}$ (6)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\left(\$321,976-\$2,560\right)\times 8\%\times \frac{3}{12}\\ =\$6,388\end{array}$ (7)

Calculate bond premium.

$\begin{array}{c}\text{Bond premium}=\text{Cash interest payment}-\text{Interest Expense }\\ =\$9,000-\$6,388\\ =\$2,612\end{array}$ (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)				6,336
		Bond Premium (11)				2,664
			Cash (9)				9,000
				(To record payment of interest)

Table (6)

• Interest expense is an expense and it decreases the equity value. So, debit it by $6,336.
• Bond premium is an adjunct liability account and it is decreased. So, debit it by $2,664.
• Cash is an asset and it is decreased. So, credit it by $9,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$300,000\times 12\%\times \frac{3}{12}\\ =\$9,000\end{array}$ (9)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\left(\$321,976-\$2,560-\$2,612\right)\times 8\%\times \frac{3}{12}\\ =\$6,336\end{array}$ (10)

Calculate bond Premium.

$\begin{array}{c}\text{Bond premium}=\text{Cash interest payment}-\text{Interest Expense }\\ =\$9,000-\$6,336\\ =\$2,664\end{array}$ (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)				6,283
		Bond Premium (14)				2,717
			Cash (12)				9,000
				(To record payment of interest)

Table (7)

• Interest expense is an expense and it decreases the equity value. So, debit it by $6,283.
• Bond premium is an adjunct liability account and it is decreased. So, debit it by $2,717.
• Cash is an asset and it is decreased. So, credit it by $9,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$300,000\times 12\%\times \frac{3}{12}\\ =\$9,000\end{array}$ (12)

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Book value of bond }\times \text{Market interest}\times \text{Time}\\ =\left(\$321,976-\$2,560-\$2,612-\$2,664\right)\times 8\%\times \frac{3}{12}\\ =\$6,283\end{array}$ (13)

Calculate bond premium.

$\begin{array}{c}\text{Bond premium}=\text{Cash interest payment}-\text{Interest Expense }\\ =\$9,000-\$6,283\\ =\$2,717\end{array}$ (14)

3.

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 S Balance Sheet (Partial) As of December 31
Long-term Liabilities:
Bonds Payable (15)	$311,423

Table (8)

Working note:

Calculate the amount of bonds payable on December 31.

$\begin{array}{c}\text{Bonds payable on December 31 =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ -\text{Premium amortized on March 31}\\ -\text{Premium amortized on June 30}\\ -\text{Premium amortized on September 30}\\ -\text{Premium amortized on December 31}\end{array}\right)\\ =\left(\$321,976-\$2,560-\$2,612-\$2,664-\$2,717\right)\\ =\$311,423\end{array}$ (15)