Chapter 10, Problem 18AE

To determine

Prepare the journal entries to record the bond transactions for year 1 and year 2.

Explanation of Solution

Straight line amortization bond:

Straight line method of amortization is a process of amortizing premium on bond or discount on bond, which allocates the same amount of interest expense in each period of interest payment.

Prepare the journal entry to record issuance of bonds payable on January 1, Year 1 as follows:

Date	Account titles and Explanation	Debit	Credit
January 1, Year 1	Cash	$285,600
	Premium on bonds payable		$5,600
	Bonds payable		$280,000
	(To record the issuance of bonds payable with premium)

Table (1)

Working notes:

Calculate premium on bonds payable.

$\begin{array}{c}\text{Cash received = Face value of bonds }\times \text{Selling price of bonds}\\ \text{=}\text{\$280,000}\times 102\%\\ =\$285,600\end{array}$

Calculate premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = Cash received}-\text{Face value of bonds}\\ \text{=}\text{\$285,600}-\$280,000\\ =\$5,600\end{array}$

• Cash is a current asset, and it is increased. Therefore, debit cash account for $285,600.
• Premium on bonds payable is an adjunct liability, and it is increased. Therefore, credit premium on bonds payable account for $5,600.
• Bonds payable is a long term liability, and it is increased. Therefore, credit bonds payable account for $280,000.

Prepare the journal entry to record the payment of interest expense on June 30, Year 1 as follows:

Date	Account titles and Explanation	Debit	Credit
June 30, Year 1	Interest expense	$7,840
	Premium on bonds payable	$560
	Cash		$8,400
	(To record the payment for interest expense with premium)

Table (2)

Working notes:

Calculate premium on bonds payable (premium amortization).

$\begin{array}{c}\text{Premium amortization = }\frac{\text{Total premium on bonds payable}}{\text{Number of periods}}\\ =\frac{\$5,600}{10\text{Periods}}\\ =\$560\end{array}$

Calculate cash paid.

$\begin{array}{c}\text{Cash paid = Face value of bonds }\times \text{Stated interest rate}\times \text{Time period}\\ \text{=}\text{\$280,000}\times \text{6\%}\times \frac{6}{12}\\ \text{=}\text{\$8,400}\end{array}$

Calculate interest expenses.

$\begin{array}{c}\text{Interest expenses = Cash paid }-\text{Premium on bonds payable}\\ \text{=}\text{\$8,400}-\text{\$560}\\ \text{=}\text{\$7,840}\end{array}$

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $7,840.
• Premium on bonds payable is an adjunct liability, and it is decreased. Therefore, debit premium on bonds payable account for $560.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $8,400.

Prepare the journal entry to record the payment of interest expense on December 31, Year 1 as follows:

Date	Account titles and Explanation	Debit	Credit
December 31, Year 1	Interest expense	$7,840
	Premium on bonds payable	$560
	Cash		$8,400
	(To record the payment for interest expense with premium)

Table (3)

Working notes:

Calculate premium on bonds payable (premium amortization).

$\begin{array}{c}\text{Premium amortization = }\frac{\text{Total premium on bonds payable}}{\text{Number of periods}}\\ =\frac{\$5,600}{10\text{Periods}}\\ =\$560\end{array}$

Calculate cash paid.

$\begin{array}{c}\text{Cash paid = Face value of bonds }\times \text{Stated interest rate}\times \text{Time period}\\ \text{=}\text{\$280,000}\times \text{6\%}\times \frac{6}{12}\\ \text{=}\text{\$8,400}\end{array}$

Calculate interest expenses.

$\begin{array}{c}\text{Interest expenses = Cash paid }-\text{Premium on bonds payable}\\ \text{=}\text{\$8,400}-\text{\$560}\\ \text{=}\text{\$7,840}\end{array}$

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $7,840.
• Premium on bonds payable is an adjunct liability, and it is decreased. Therefore, debit premium on bonds payable account for $560.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $8,400.

Prepare the journal entry to record the payment of interest expense on June 30, Year 2 as follows:

Date	Account titles and Explanation	Debit	Credit
June 30, Year 2	Interest expense	$7,840
	Premium on bonds payable	$560
	Cash		$8,400
	(To record the payment for interest expense with premium)

Table (4)

Working notes:

Calculate premium on bonds payable (premium amortization).

$\begin{array}{c}\text{Premium amortization = }\frac{\text{Total premium on bonds payable}}{\text{Number of periods}}\\ =\frac{\$5,600}{10\text{Periods}}\\ =\$560\end{array}$

Calculate cash paid.

$\begin{array}{c}\text{Cash paid = Face value of bonds }\times \text{Stated interest rate}\times \text{Time period}\\ \text{=}\text{\$280,000}\times \text{6\%}\times \frac{6}{12}\\ \text{=}\text{\$8,400}\end{array}$

Calculate interest expenses.

$\begin{array}{c}\text{Interest expenses = Cash paid }-\text{Premium on bonds payable}\\ \text{=}\text{\$8,400}-\text{\$560}\\ \text{=}\text{\$7,840}\end{array}$

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $7,840.
• Premium on bonds payable is an adjunct liability, and it is decreased. Therefore, debit premium on bonds payable account for $560.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $8,400.

Prepare the journal entry to record the payment of interest expense on December 31, Year 2 as follows:

Date	Account titles and Explanation	Debit	Credit
December 31, Year 2	Interest expense	$7,840
	Premium on bonds payable	$560
	Cash		$8,400
	(To record the payment for interest expense with premium)

Table (5)

Working notes:

Calculate premium on bonds payable (premium amortization).

$\begin{array}{c}\text{Premium amortization = }\frac{\text{Total premium on bonds payable}}{\text{Number of periods}}\\ =\frac{\$5,600}{10\text{Periods}}\\ =\$560\end{array}$

Calculate cash paid.

$\begin{array}{c}\text{Cash paid = Face value of bonds }\times \text{Stated interest rate}\times \text{Time period}\\ \text{=}\text{\$280,000}\times \text{6\%}\times \frac{6}{12}\\ \text{=}\text{\$8,400}\end{array}$

Calculate interest expenses.

$\begin{array}{c}\text{Interest expenses = Cash paid }-\text{Premium on bonds payable}\\ \text{=}\text{\$8,400}-\text{\$560}\\ \text{=}\text{\$7,840}\end{array}$

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $7,840.
• Premium on bonds payable is an adjunct liability, and it is decreased. Therefore, debit premium on bonds payable account for $560.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $8,400.