Chapter 10, Problem 30BP

a.

To determine

Identify the amount received by the Company K.

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.

Company K will receive an amount of $194,000 in cash because the bonds are sold at a discount, which means stated rate of interest is less than the market rate of interest. The amount determined as interest will act to equate the two interest rates. Therefore, if the bonds are sold at face value the Company K would have received $194,000.

b.

To determine

Prepare journal entry to record the given transactions.

Explanation of Solution

Prepare journal entry to record the issuance of bond.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
March 1, Year 1	Cash	194,000
	Discount on bonds payable	6,000
	Bonds payable		200,000
	(To record the issuance of bond)

(Table 1)

• Cash is an asset and there is an increase in the value of an asset. Hence, debit the cash by $194,000.
• Discount on bonds payable is a contra liability and it is increased. Hence, debit the discount on bonds payable by $6,000.
• Bonds payable is a liability is a long term liability, and it is increased. Hence, credit bonds payable account for $200,000.

Prepare journal entry to recognize interest expense for Year 1.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
September 1	Interest expense	6,375
	Cash (1)		6,000
	Discount on bonds payable (2)		375
	(To recognize interest expense)

(Table 2)

• Interest expense is a component of stockholder’s equity and there is an increase in the value of an expense. Hence, debit the interest expense by $6,375.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $6,000.
• Discount on bonds payable is a contra liability, and it is decreased. Hence, credit discount on bonds payable account for $375.

Prepare journal entry to recognize accrued interest expense for Year 1.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
December 31	Interest expense	4,250
	Discount on bonds payable (3)		250
	Interest payable (4)		4,000
	(To recognize accrued interest expense)

(Table 3)

• Interest expense is a component of stockholder’s equity and there is an increase in the value of an expense. Hence, debit the interest expense by $4,250.
• Discount on bonds payable is a contra liability, and it is decreased. Hence, credit discount on bonds payable account for $250.
• Interest payable is a liability and there is an increase in the value of a liability. Hence, credit the interest payable by $4,000.

Prepare journal entry to close interest expense account for Year 1.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
December 31	Retained earnings	10,625
	Interest expense		10,625
	(To close the interest expense account)

(Table 4)

• Retained earnings are a component of stockholder’s equity and there is a decrease in the value of revenue. Hence, debit the retained earnings by $10,625.
• Interest expense is a component of stockholder’s equity and there is a decrease in the value of expense, while closing the expense account. Hence, debit the interest expense by $10,625.

Prepare journal entry to recognize interest expense for Year 2.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
March 1, Year 2	Interest expense (6)	2,125
	Interest payable	4,000
	Discount on bonds payable (5)		125
	Cash		6,000
	(To recognize interest expense)

(Table 5)

• Interest expense is a component of stockholder’s equity and there is an increase in the value of an expense. Hence, debit the interest expense by $2,125.
• Interest payable is a liability and there is a decrease in the value of a liability. Hence, debit the interest payable by $4,000.
• Discount on bonds payable is a contra liability, and it is decreased. Hence, credit discount on bonds payable account for $125.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $6,000.

Prepare journal entry to recognize interest expense for Year 2.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
September 1	Interest expense	6,375
	Cash		6,000
	Discount on bonds payable		375
	(To recognize interest expense)

(Table 6)

• Interest expense is a component of stockholder’s equity and there is an increase in the value of an expense. Hence, debit the interest expense by $6,375.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $6,000.
• Discount on bonds payable is a contra liability, and it is decreased. Hence, credit discount on bonds payable account for $375.

Prepare journal entry to recognize accrued interest expense for Year 2.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
December 31	Interest expense	4,250
	Discount on bonds payable (3)		250
	Interest payable (4)		4,000
	(To recognize accrued interest expense)

(Table 7)

• Interest expense is a component of stockholder’s equity and there is an increase in the value of an expense. Hence, debit the interest expense by $4,250.
• Discount on bonds payable is a contra liability, and it is decreased. Hence, credit discount on bonds payable account for $250.
• Interest payable is a liability and there is an increase in the value of a liability. Hence, credit the interest payable by $4,000.

Prepare journal entry to close interest expense account for Year 2.

Date	Account Titles and Explanation	Debit ($)	Credit ($)
December 31	Retained earnings	12,750
	Interest expense		12,750
	(To close the interest expense account)

(Table 8)

• Retained earnings are a component of stockholder’s equity and there is a decrease in the value of revenue. Hence, debit the retained earnings by $12,750.
• Interest expense is a component of stockholder’s equity and there is a decrease in the value of expense, while closing the expense account. Hence, credit the interest expense by $12,750.

Working Notes:

Calculate the amount of cash paid.

$\begin{array}{c}\text{Cash Paid = Bonds issued }\times \text{Interest rate }\times \text{ Time period}\\ \text{=\$200,000}\times \text{6\%}\times \frac{6}{12}\\ \text{=\$6,000}\end{array}$ (1)

Calculate the amount of discount on bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable }\\ \text{at September 31}\end{array}\}\text{ =}\frac{\left(\begin{array}{l}\text{Discount on bond payable}\\ \text{ at March 1}\end{array}\right)}{\text{Number of years}}\times \text{Time period}\\ =\frac{\$6,000}{8}\times \frac{6}{12}\\ =\$375\end{array}$ (2)

Calculate the amount of discount on bonds payable at December 31, Year 1.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable }\\ \text{at December 31}\end{array}\}\text{ =}\frac{\left(\begin{array}{l}\text{Discount on bond payable}\\ \text{ at March 1}\end{array}\right)}{\text{Number of years}}\times \text{Time period}\\ =\frac{\$6,000}{8}\times \frac{4}{12}\\ =\$250\end{array}$ (3)

Calculate the amount of interest payable at December 31, Year 1.

$\begin{array}{c}\begin{array}{l}\text{Interest payable }\\ \text{at December 31}\end{array}\}\text{ =Bonds issued }\times \text{ Interest rate }\times \text{Time period}\\ =\$200,000\times 6\%\times \frac{4}{12}\\ =\$4,000\end{array}$ (4)

Calculate the amount of discount on bonds payable at December 31, Year 2.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable }\\ \text{at December 31}\end{array}\}\text{ =}\frac{\left(\begin{array}{l}\text{Discount on bond payable}\\ \text{ at March 1}\end{array}\right)}{\text{Number of years}}\times \text{Time period}\\ =\frac{\$6,000}{8}\times \frac{2}{12}\\ =\$125\end{array}$ (5)

Calculate the amount of interest expense at March 1, Year 2.

$\begin{array}{c}\text{Interest expense}=\left[\left(\begin{array}{l}\text{Cash paid on,}\\ \text{September1,Year1}\end{array}\right)-\left(\begin{array}{l}\text{Interest payable on}\\ \text{ December1,Year1}\end{array}\right)\right]+\left(\begin{array}{l}\text{Discount on bonds }\\ \text{payable atDecember }\\ \text{31,Year 1}\end{array}\right)\\ =\left[\$6,000-\$4,000\right]+\$125\\ =\$2,125\end{array}$ (6)

c.

To determine

Prepare the liabilities section of the balance sheet at December 31, Year 1.

Explanation of Solution

Prepare the liabilities section of the balance sheet at December 31, Year 1.

Partial balance sheet
At December 3, Year 1.
Particulars	Year 1	Year 2
Liabilities
Interest Payable	4,000	4,000
Bonds Payable	200,000	200,000
Less: Discount on Bonds Payable	(3) (5,375)	(4) (4,625)
Carrying Value of Bonds Payable	194,625	195,375

(Table 9)

Working Notes:

Calculate the amount of discount on bonds payable for Year 1.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable}\\ \text{ at Year 1}\end{array}\}\text{ =}\left(\begin{array}{l}\text{Discount on bond}\\ \text{ payable at March 1}\end{array}\right)-\left(\begin{array}{l}\text{Discount on bond payable}\\ \text{ at September 1}+\text{Discount on}\\ \text{ bond payable at December 31}\end{array}\right)\\ =\$6,000-\left(\$375+\$250\right)\\ =\$6,000-\$625\\ =\$5,375\end{array}$ (3)

Calculate the amount of discount on bonds payable for Year 2.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable}\\ \text{ at Year 2}\end{array}\}\text{ =}\left(\begin{array}{l}\text{Discount on bond}\\ \text{ payable at }\\ \text{ Year 1}\end{array}\right)-\left(\begin{array}{l}\text{ Discount on bond payable}\\ \text{ at March 1}+\text{Discount on bond}\\ \text{ payable at September 1}+\\ \text{Discount on bond payable }\\ \text{at December 31}\end{array}\right)\\ =\$5,375-\left(\$125+\$375+\$250\right)\\ =\$5,375-\$750\\ =\$4,625\end{array}$ (4)

d.

To determine

Identify the amount of interest expense that will be reported on the income statements for the Year 1 and Year 2.

Explanation of Solution

The amount of interest expense that will be reported on the income statements for the Year 1 and Year 2 is $10,625.

e.

To determine

Identify the amount of interest expense that will be paid in cash to the bondholders in Year 1 and Year 2.

Explanation of Solution

The amount of interest expense that will be paid in cash to the bondholders in Year 1 and Year 2 is $6,000.