Concept explainers
a)
Prepare a
a)
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.
Prepare a journal entry to record the issuance of the bonds on August 1, 2018:
Date | Account title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
August 1, 2018 | Cash | 10,250,000 | ||
Bonds payable | 10,000,000 | |||
Bonds interest payable (1) | 250,000 | |||
(To record the issuance of bonds and 3 months accrued interest) |
Table (1)
- Cash (asset) is increased by $10,250,000. Thus, it is debited.
- Bonds payable (liability) is increased by $10,000,000. Thus, it is credited.
- Bonds interest payable (liability) is increased by 250,000. Thus, it is credited.
Working note:
The bonds were issued on August 1, 2018, at 100 plus three months’ accrued interest. Interest rate is 10%.
Calculate the bonds interest payable (3 months accrued interest):
b)
Prepare a journal entry to record the first semi-annual interest payment on the issued bond on November 1, 2018.
b)
Explanation of Solution
Interest: Interest is an amount paid on the issue price of the bonds by the company at stated dates at stated rate of interest.
Prepare a journal entry to record the first semi-annual interest payment on the issued bond on November 1, 2018:
Date | Account title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
November 1, 2018 | Bonds interest payable(2) | 250,000 | ||
Bonds interest expense (3) | 250,000 | |||
Cash | 500,000 | |||
(To record the first semi-annual interest on bonds) |
Table (1)
- Bonds interest payable (liability) is decreased by 250,000. Thus, it is debited.
- Bond interest expense (decreases the equity) is increased by $250,000. Thus, it is debited.
- Cash (asset) is decreased by $500,000. Thus, it is credited.
Working note:
The bonds are dated May 1, 2018. The bonds were issued on August 1, 2018, at 100 plus three months’ accrued interest. Interest rate is 10%. May to July is 3 months; August to October is 3 months (interest incurred period).
Calculate the bonds interest payable (3 months accrued interest):
Calculate the bonds interest payable
c)
Prepare a journal entry to record interest expense accrued through year-end on December 31, 2018.
c)
Explanation of Solution
Accrued expenses: Accrued expenses are the expenses that have been incurred but have not been paid yet. These accrued expenses create accrued liabilities. For the portion of payment made, accrued liabilities would be reduced by way of passing an
Example: Accrued salaries expense and accrued interest expense.
Prepare a journal entry to record interest expense accrued through year-end on December 31, 2018:
Date | Account title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
December 31, 2018 | Bonds interest expense | 166,667 | ||
Bonds interest payable (4) | 166,667 | |||
(To record the issuance of bonds and 2 months accrued interest) |
Table (1)
- Bond interest expense (decreases the equity) is increased by $166,667. Thus, it is debited.
- Bonds interest payable (liability) is increased by 166,667. Thus, it is credited.
Working note:
Calculate the accrued interest (2 months accrued interest):
d)
Prepare a journal entry to record the second semi-annual interest payment on May 1, 2019.
d)
Explanation of Solution
Prepare a journal entry to record the second semi-annual interest payment on the issued bonds on May 1, 2019:
Date | Account title and Explanation | Post Ref. |
Debit ($) |
Credit ($) |
May 1, 2019 | Bonds interest payable(4) | 166,667 | ||
Bonds interest expense (5) | 333,333 | |||
Cash | 500,000 | |||
(To record the first semi-annual interest on bonds) |
Table (1)
- Bonds interest payable (liability) is decreased by 166,667. Thus, it is debited.
- Bond interest expense (decreases the equity) is increased by $333,333. Thus, it is debited.
- Cash (asset) is decreased by $500,000. Thus, it is credited.
Working note:
In the second semi-annual interest payment, 2 months interest is recorded as accrued interest for a year end adjustment. This adjustment entry is reversed and interest expense is calculated for remaining 4 months (January to April).
Calculate the bonds interest expense:
e)
Find the prevailing market rate of interest on the date that the bonds were issued and explain the same.
e)
Explanation of Solution
10% is the prevailing market rate of interest on the date that the bonds were issued. The reason for it is the bonds were issued at par ($100) and the market rate had to have equalled the contract interest rate printed on the bonds.
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