Chapter 10, Problem 3AP

1.

To determine

Calculate the issue 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.

Bond Discount: It occurs when the bonds are issued at a lower price than the face value.

Straight-line amortization method: It is a method of bond amortization that spreads the amount of the bond discount or bond premium equally over the interest period.

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

Determine the issue price of the bonds.

Step 1: Calculate the cash interest payment for bonds.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$1,000,000\times 7\%\times 1\\ =\$70,000\end{array}$

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

Particulars	Amount
Interest payment (a)	$70,000
PV factor at annual market interest rate of 9% for 5 periods (b)	3.8897
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$272,279

Table (1)

Note: The present value factor for 5 periods at 9% interest would be 3.8897 (Refer Appendix A (Table A.2) in the book for present value factor).

Step 3: Calculate the present value of single principal payment of $1,000,000 (principal amount) at 9% for 5 periods.

Particulars	Amount
Single principal payment (a)	$1,000,000
PV factor at annual market interest rate of 9% for 5 periods (b)	0.6499
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$649,900

Table (2)

Note: The present value factor for 5 periods at 9% interest would be 0.6499 (Refer Appendix A (Table A.1) in the book for present value factor).

Step 4: Calculate the issue price of the bonds.

$\begin{array}{c}\text{Issue price of the bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of single principal payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$272,279}\left(\text{from table 1}\right)\\ +\text{\$649,900}\left(\text{from table 2}\right)\end{array}\right)\\ =\text{\$922,179}\end{array}$

Conclusion

Hence, the issue price of the bonds on January 1, 2014 is $922,179.

2.

a.

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.

Step 1: Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$1,000,000\times 7\%\times 1\\ =\$70,000\end{array}$

Step 2: Calculate discount on bonds payable, annually.

$\begin{array}{c}\begin{array}{l}\text{Discount on bonds payable, }\\ \text{annually }\end{array})\text{=}\frac{\text{Total bond discount}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\left(\$1,000,000-\$922,179\right)}{5}\\ \text{=}\text{\$15,564 }\end{array}$

Step 3: Calculate interest expense.

$\begin{array}{c}\text{Interest Expense}=\text{Cash interest payment}\text{+}\text{Bond discount }\\ =\$70,000+\$15,564\\ =\$85,564\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on December 31, 2014 is $85,564.

b.

To determine

Calculate the amount of interest expense that should be recorded on December 31, 2015.

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 should be recorded on December 31, 2015.

Step 1: Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$1,000,000\times 7\%\times 1\\ =\$70,000\end{array}$

Step 2: Calculate discount on bonds payable, annually.

$\begin{array}{c}\begin{array}{l}\text{Discount on bonds payable, }\\ \text{annually }\end{array})\text{=}\frac{\text{Total bond discount}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\left(\$1,000,000-\$922,179\right)}{5}\\ \text{=}\text{\$15,564 }\end{array}$

Step 3: Calculate interest expense.

$\begin{array}{c}\text{Interest Expense}=\text{Cash interest payment}\text{+}\text{Bond discount }\\ =\$70,000+\$15,564\\ =\$85,564\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on December 31, 2015 is $85,564.

3.

a.

To determine

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

$\begin{array}{c}\text{Cash interest paid}=\left(\begin{array}{l}\text{Face value of bond }\times \text{coupon rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= }\$1,000,000\times 7\%\times 1\\ =\$70,000\end{array}$

Conclusion

Hence, amount of cash interest that should be paid on December 31, 2014 is $70,000.

b.

To determine

Calculate the amount of cash interest that should be paid on December 31, 2015.

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 interest that should be paid on December 31, 2015.

$\begin{array}{c}\text{Cash interest paid}=\left(\begin{array}{l}\text{Face value of bond }\times \text{coupon rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= }\$1,000,000\times 7\%\times 1\\ =\$70,000\end{array}$

Conclusion

Hence, amount of cash interest that should be paid on December 31, 2015 is $70,000.

4.

a.

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.

$\begin{array}{c}\begin{array}{l}\text{Book value of bond }\\ \text{on December 31, 2014}\end{array})\text{ =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ \text{+}\text{Discount amortized on December 31, 2014}\end{array}\right)\\ =\$922,179+\$15,564\\ =\$937,743\end{array}$

Conclusion

Hence, the book value of the bonds on December 31, 2014 is $937,743.

b.

To determine

Calculate the book value of the bonds on December 31, 2015.

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, 2015.

$\begin{array}{c}\begin{array}{l}\text{Book value of bond}\\ \text{ on December 31, 2015 }\end{array})\text{=}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ \text{+}\text{Discount amortized on December 31, 2014}\\ \text{+}\text{Discount amortized on December 31, 2015}\end{array}\right)\\ =\$922,179+\$15,564+\$15,564\\ =\$953,307\end{array}$

Conclusion

Hence, the book value of the bonds on December 31, 2015 is $953,307.