Chapter 10, Problem 5AP

1.

To determine

Prepare the journal entry to record issuance of bonds payable at discount on January 1, 2017.

Explanation of Solution

Bonds: Bonds are long-term promissory notes that are represented by a company while borrowing money from investors to raise fund for financing the operations.

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.

Prepare journal entry for issuance of bonds payable on January 1, 2017.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Cash				292,181
January 1		Discount on Bonds Payable				32,819 (1)
			Bonds Payable				325,000
				(To record issuance of bonds payable at discount)

Table (1)

Working Note:

Calculate the amount of total bonds discount.

Par value of bonds = $325,000

Issue price of bonds = $292,181

$\begin{array}{c}\text{Total bonds discount = Par}\text{value of bonds}-\text{Cash received from issued of bonds}\\ =\$325,000-\$292,181\\ =\$32,819\end{array}$ (1)

Description:

• Cash is an asset and it is increased. So, debit it by $292,181.
• Discount on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $32,819.
• Bonds payable is a liability and it is increased. So, credit it by $325,000.

2.

To determine

Calculate the total bond interest expense that will be recognized over the life of the bonds.

Explanation of Solution

Calculate the total bond interest expense.

Details	Amount ($)
Total interest payments for 4 years (8 Semiannual payments)	65,000 (2)
Add: Discounts	32,819 (1)
Total bond interest expense	97,819

Table (2)

Working Note:

Calculate the total interest payments for 4 years (semi-annually).

$\begin{array}{c}\begin{array}{l}\text{Total interest payments for}\\ \text{4 years (semi-annually)}\end{array}]=\left(\text{Par value}\times \text{Interest rate}\times \frac{1}{2}\right)\times 8\\ =\left(\$325,000\times 5\%\times \frac{1}{2}\right)\times 8\\ =\$8,125\times 8\\ =\$65,000\end{array}$ (2)

Conclusion

Therefore the total interest payment for 4 years (semi-annually) is $97,819.

3.

To determine

Prepare an amortization table for the first two years of the bonds using straight-line method to amortize the discount. 

Explanation of Solution

Prepare an amortization table for the first two years of the bonds using straight-line method to amortize the discount.

Date	Discount Unamortized ($)	Carrying Amount ($)
01/01/2017	32,819	292,181
30/06/2017	28,717	296,283
31/12/2017	24,615	300,385
30/06/2018	20,513	304,487
31/12/2018	16,411	308,589

Table (3)

Note: The amortization of bond discount per interest payment is $4,102 (3).

Working Note:

Calculate amortization of bond discount per interest payment.

Total bonds discount = $32,819 (1)

Number of semiannual payments = 8 (4 years semiannual payments)

$\begin{array}{c}\text{Amortization of bond discount per interest payment = }\frac{\text{Total bonds discount}}{\text{Number}\text{of}\text{semiannual}}\\ =\frac{\$32,819}{8}\\ =\$4,102\end{array}$ (3)

4.

To determine

Prepare the journal entry to record semiannual interest and amortization of discount on bonds.

Explanation of Solution

Prepare journal entry for payment of semiannual interest and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Bond Interest Expense (5)				12,227
June	30		Discount on Bonds Payable  (3)				4,102
			Cash (4)				8,125
				(To record semiannual payment of interest and amortization of discount on bonds)

Table (4)

Working notes:

Calculate the amount of cash interest paid (semiannually).

Par value of bonds = $325,000

Interest rate = 5%

$\begin{array}{c}\text{Cash interest}=\left(\begin{array}{l}\text{Par value}\times \text{Interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$325,000\times \frac{5}{100}\times \frac{1}{2}\\ =\$8,125\end{array}$ (4)

Calculate the interest expense on the bond as on June 30, 2017.

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Cash}\text{Interest +Discount}onBondsPayable\\ =\$8,125+\$4,102\\ =\$12,227\end{array}$ (5)

• Interest expense is an expense and it decreases the equity value. So, debit it by $12,227.
• Discount on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $4,102.
• Cash is an asset and it is decreased. So, credit it by $8,125.

Prepare journal entry for payment of semiannual interest and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Bond Interest Expense (6)				12,227
December	31		Discount on Bonds Payable  (3)				4,102
			Cash (4)				8,125
				(To record semiannual payment of interest and amortization of discount on bonds)

Table (5)

Working notes:

Calculate the interest expense on the bond as on December 31, 2017.

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Cash}\text{Interest +Discount}onBondsPayable\\ =\$8,125+\$4,102\\ =\$12,227\end{array}$ (6)

• Interest expense is an expense and it decreases the equity value. So, debit it by $12,227.
• Discount on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $4,102.
• Cash is an asset and it is decreased. So, credit it by $8,125.

5.

To determine

Explain the changes on the amounts reported on the financial statements assuming the market rate on January 1, 2017 as 4% instead of 8%.

Explanation of Solution

If the market rate on January 1, 2017 is 4% instead of 8% then the bonds must have issued at a premium as the contract rate of 5% is higher than the changed market rate of 4%.