Chapter 10, Problem 4AP

1.

To determine

Calculate the issuance 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.

Effective-interest method of amortization: It is an amortization model that apportions the amount of bond discount or premium based on the market interest rate.

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

Determine the issuance price of the bonds.

Step 1: Calculate the cash interest payment for bonds.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 6\%\times 1\\ =\$120,000\end{array}$

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

Particulars	Amount
Interest payment (a)	$120,000
PV factor at annual market interest rate of 7% for 5 periods (b)	4.1002
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$492,024

Table (1)

Note: The present value factor for 5 periods at 7% interest would be 4.1002 (Refer Appendix A (Table A.2) in the book for present value factor).

Step 3: Calculate the present value of single principal payment of $2,000,000 (principal amount) at 7% for 5 periods.

Particulars	Amount
Single principal payment (a)	$2,000,000
PV factor at annual market interest rate of 7% for 5 periods (b)	0.7130
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$1,426,000

Table (2)

Note: The present value factor for 5 periods at 7% interest would be 0.7130 (Refer Appendix A (Table A.1) in the book for present value factor).

Step 4: Calculate the issue price of the bonds.

$\begin{array}{c}\text{Issue price of the bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of single principal payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$492,024}\left(\text{from table 1}\right)\\ +\text{\$1,426,000}\left(\text{from table 2}\right)\end{array}\right)\\ =\text{\$1,918,024}\end{array}$

Conclusion

Hence, the issuance price of the bonds on January 1, 2014 is $1,918,024.

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.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Book value of bond }\left(\text{issue price}\right)\times \text{Market interest rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= \$1,918,024}\times 7\%\times 1\\ =\$134,262\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on December 31, 2014 is $134,262.

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 that should be recorded on December 31, 2015.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Book value of bond }\times \text{Market interest rate}\\ \times \text{Interest}\text{time period}\end{array}\right)\\ \text{= }\left(\$1,918,024+\left(\$134,262-\$120,000\right)\right)\times 7\%\times 1\\ =\$135,260\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on December 31, 2014 is $135,260.

3.

a.

To determine

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

$\begin{array}{c}\text{Cash paid}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 6\%\times 1\\ =\$120,000\end{array}$

Conclusion

Hence, amount of cash that should be paid to investors on December 31, 2014 is $120,000.

b.

To determine

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

$\begin{array}{c}\text{Cash paid}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 6\%\times 1\\ =\$120,000\end{array}$

Conclusion

Hence, amount of cash that should be paid to investors on December 31, 2015 is $120,000.

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.

$\begin{array}{c}\begin{array}{l}\text{Book value of bond }\\ \text{on December 31, 2014}\end{array})\text{ =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ \text{+}\text{Discount amortized on December 31, 2014}\end{array}\right)\\ =\left(\$1,918,024+\left(\$134,262-\$120,000\right)\right)\\ =\$1,932,286\end{array}$

Conclusion

Hence, the book value of the bonds on December 31, 2014 is $1,932,286.

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.

$\begin{array}{c}\begin{array}{l}\text{Book value of bond }\\ \text{on December 31, 2015 }\end{array})\text{=}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ \text{+}\text{Discount amortized on December 31, 2014}\\ \text{+Discount amortized on December 31, 2015}\end{array}\right)\\ =\left(\begin{array}{l}\$1,918,024+\left(\$134,262-\$120,000\right)\\ +\left(\$135,260-\$120,000\right)\end{array}\right)\\ =\$1,947,546\end{array}$

Conclusion

Hence, the book value of the bonds on December 31, 2015 is $1,947,546.