Chapter 10, Problem 15AE

a.

To determine

Prepare the journal entries to record issuing the bonds and any necessary journal entries for Year 1 and Year 2, post them to T-accounts, and prepare any necessary closing entries for Year 1.

Explanation of Solution

Bonds:

Bonds are a kind of interest bearing notes payable, usually issued by companies, universities and governmental organizations. It is a debt instrument used for the purpose of raising fund of the corporations or governmental agencies. If selling price of the bond is equal to its face value, it is called as par on bond. If selling price of the bond is lesser than the face value, it is known as discount on bond. If selling price of the bond is greater than the face value, it is known as premium on bond.

Prepare the journal entries to record issuing the bonds and any necessary journal entries for Year 1 and Year 2 as follows:

Date	Account titles and Explanation	Debit (in $)	Credit (in $)
July 1, Year 1	Cash (1)	204,000
	Premium on bonds payable		4,000
	Bonds payable		200,000
	(To record issuance of bonds payable at premium)

Table (1)

Working note:

Calculate Cash amount.

$\begin{array}{c}\text{Cash =}\text{Bonds payable }\times 1.02\\ \text{=}\text{\$200,000}\times 1.02\\ =\$204,000\end{array}$ (1)

• Cash is a current asset, and it is increased. Therefore, debit cash account.
• Premium on bonds payable is an adjunct liability, and it is decreased. Therefore, debit discount on bonds payable account.
• Bonds payable is a long term liability, and it is increased. Therefore, credit bonds payable account.

Prepare the journal entry to record the payment of semi- annual interest expense as on December 31.

Date	Account titles and Explanation	Debit (in $)	Credit (in $)
December 31, Year 1	Interest expense	5,800
	Premium on bonds payable (2)	200
	Cash (3)		6,000
	(To record payment of semi- annual interest expenses)

Table (2)

Working notes:

Calculate Premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable}\left(\text{Amortization}\right)\text{ = }\left(\frac{\text{Premium on bonds payable}}{\text{Estimated years}}\times \text{Time period}\right)\\ \text{=}\frac{\$4,000}{10\text{years}}\times \frac{6}{12}\text{months}\\ \text{=\$200}\end{array}$ (2)

Calculate Cash amount.

$\begin{array}{c}\text{Cash =}\text{Bonds payable }\times \text{Stated interest rate}\times \text{Time period}\\ \text{=}\text{\$200,000}\times 6\text{\%}\times \frac{6}{12}\\ =\$6,000\end{array}$ (3)

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account.
• Premium on bonds payable is an adjunct liability, and it is increased. Therefore, credit discount on bonds payable account.
• Cash is a current asset, and it is decreased. Therefore, credit cash account.

Prepare the journal entry to record the closing entry of the interest expense account.

Date	Account titles and Explanation	Debit (in $)	Credit (in $)
December 31, Year 1	Retained earnings	5,800
	Interest expense		5,800
	(To close the interest expense account to retained earnings account)

Table (3)

• Retained earnings are increased and hence debit the retained earnings account.
• Interest expense account is an expense account, which is a component of stockholders’ equity. Interest expense account is increased, which decreased the stockholders’ equity. Hence, credit it.

Prepare the journal entry to record the payment of semi- annual interest expense as on June 30.

Date	Account titles and Explanation	Debit (in $)	Credit (in $)
June 30, Year 2	Interest expense	5,800
	Premium on bonds payable	200
	Cash		6,000
	(To record payment of semi- annual interest expenses)

Table (4)

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account.
• Premium on bonds payable is an adjunct liability, and it is increased. Therefore, credit discount on bonds payable account.
• Cash is a current asset, and it is decreased. Therefore, credit cash account.

Prepare the journal entry to record the payment of semi- annual interest expense as on December 31.

Date	Account titles and Explanation	Debit (in $)	Credit (in $)
December 31, Year 2	Interest expense	5,800
	Premium on bonds payable	200
	Cash		6,000
	(To record payment of semi- annual interest expenses)

Table (5)

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account.
• Premium on bonds payable is an adjunct liability, and it is increased. Therefore, credit discount on bonds payable account.
• Cash is a current asset, and it is decreased. Therefore, credit cash account.

Prepare the journal entry to record the closing entry of the interest expense account.

Date	Account titles and Explanation	Debit (in $)	Credit (in $)
December 31, Year 2	Retained earnings	11,600
	Interest expense		11,600
	(To close the interest expense account to retained earnings account)

Table (6)

• Retained earnings are increased and hence debit the retained earnings account.
• Interest expense account is an expense account, which is a component of stockholders’ equity. Interest expense account is increased, which decreased the stockholders’ equity. Hence, credit it.

Post the journal entries to T-accounts as follows:

Cash (Year 1)
7/1204,000	12/316,000
Bal.198,000

Cash (Year 2)
	6/306,000 12/31          6,000
Bal.186,000

Bonds Payable (Year 1)
	7/1200,000
	Bal.       200,000

Premium on bonds Payable (Year 1)
12/31           200	7/14,000
	Bal.           3,800

Premium on bonds Payable (Year 2)
6/30200 12/31              200
	Bal.           3,400

Retained Earnings (Year 1)
Cl  5,800
Bal.5,800

Retained Earnings (Year 2)
Cl11,600
Bal.17,400

Interest Expense (Year 1)
12/31     5,800	Cl            5,800
Bal. 0

Interest Expense (Year 2)
6/30   5,800 12/31   5,800	Cl         11,600
Bal. 0

b.

To determine

Prepare the liabilities section of the balance sheet at the end of Year 1 and Year2.

Explanation of Solution

Balance Sheet:

Balance sheet summarizes the assets, the liabilities, and the stockholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Prepare the liabilities section of the balance sheet at the end of Year 1 and Year 2 as follows:

Incorporation S
Balance Sheet as of December 31
	Year 1 (in $)	Year 2 (in $)
Liabilities
Bonds payable	200,000	200,000
Premium on bonds payable	3,800	3,400
Net carrying value of bonds	203,800	203,400
Total Liabilities	$203,800	$203,400

Table (7)

c.

To determine

Ascertain the amount of interest expense which Incorporation S will report on the financial statements for Year 1 and Year 2.

Explanation of Solution

Ascertain the amount of interest expense which Incorporation S will report on the financial statements for Year 1 and Year 2 as follows:

	Year 1	Year 2
Interest expense	$5,800	$11,600

Table (8)

d.

To determine

Ascertain the amount of cash which Incorporation S will pay for interest in Year 1 and Year 2.

Explanation of Solution

Ascertain the amount of cash which Incorporation S will pay for interest in Year 1 and Year 2 as follows:

	Year 1	Year 2
Cash outflow for interest	$6,000	$12,000

Table (9)