Chapter 10, Problem 5BP

a)

To determine

Prepare a journal entry to record the issuance of the bonds on September 1, 2015.

Explanation of Solution

Bonds: Bonds are debt securities which are issued by issuers and pay a fixed interest revenue to the bondholders.

Prepare a journal entry to record the issuance of the bonds on September 1, 2015.

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
September 1, 2015	Cash		5,075,000
	Bonds payable			5,000.000
	Bonds interest payable			75,000
	(Record the issuance of bonds and 3 months accrued interest)

Table (1)

Description:

• Cash (asset) is increased by $5,075,000. Thus, it is debited.
• Bonds payable (liability) is increased by $5,000.000. Thus, it is credited.
• Bonds interest payable (liability) is increased by 75,000. Thus, it is credited.

Working note:

Calculate the bonds interest payable (3 months accrued interest).

$\begin{array}{c}\text{3 months accrued Interest amount = Bond value}\times 6\text{\% }\times \left(3÷\text{12}\text{months}\right)\\ =\$5,000,000\times 6\text{\% }\times \left(3÷\text{12}\text{months}\right)\\ =\$75,000\end{array}$

b)

To determine

Prepare a journal entry to record the first semi-annual interest payment on the issued bond on December 1, 2015.

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 December 1, 2015.

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
December  1, 2015	Bonds interest payable		75,000
	Bonds interest expense		75,000
	Cash			150,000
	(Record the first semi-annual interest on bonds)

Table (2)

Description:

• Bonds interest payable (liability) is decreased by 75,000. Thus, it is debited.
• Bond interest expense (decreases the equity) is increased by $75,000. Thus, it is debited.
• Cash (asset) is decreased by $150,000. Thus, it is credited.

Working note:

Calculate the bonds interest expense.

From September 1 to December 1 (interest expense) three months interest expense is incurred.

$\begin{array}{c}\text{Interest amount = Bond value}\times 6\text{\% }\times \left(3÷\text{12}\text{months}\right)\\ =\$5,000,000\times 6\text{\% }\times \left(3÷\text{12}\text{months}\right)\\ =\$75,000\end{array}$

c)

To determine

Prepare a journal entry to record interest expense accrued through year-end on December 31, 2015.

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 adjusting entry.

Example: Accrued salaries expense and accrued interest expense.

Prepare a journal entry to record interest expense accrued through year-end on December 31, 2015.

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
December  31, 2015	Bonds interest expense		25,000
	Bonds interest payable			25,000
	(Record the issuance of bonds and 1 month accrued interest)

Table (3)

Description:

• Bond interest expense (decreases the equity) is increased by $25,000. Thus, it is debited.
• Bonds interest payable (liability) is increased by 25,000. Thus, it is credited.

Working note:

Calculate the accrued interest (1 month accrued interest).

$\begin{array}{c}\text{1 month accrued Interest amount = Bond value}\times 6\text{\% }\times \left(1÷\text{12}\text{months}\right)\\ =\$5,000,000\times 6\text{\% }\times \left(1÷\text{12}\text{months}\right)\\ =\$25,000\end{array}$

d)

To determine

Prepare a journal entry to record the second semi-annual interest payment on June 1, 2016.

Explanation of Solution

Prepare a journal entry to record the second semi-annual interest payment on the issued bonds on June 1, 2016.

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
June  1, 2016	Bonds interest payable		25,000
	Bonds interest expense		125,000
	Cash			500,000
	(To record the first semi-annual interest on bonds)

Table (4)

Description:

• Bonds interest payable (liability) is decreased by 25,000. Thus, it is debited.
• Bond interest expense (decreases the equity) is increased by $125,000. Thus, it is debited.
• Cash (asset) is decreased by $150,000. Thus, it is credited.

Working note:

In the second semi-annual interest payment, 1 month interest is recorded as accrued interest for a year end adjustment. This adjustment entry is reversed and interest expense is calculated for remaining 5 months (January 1 to June 1).

Calculate the bonds interest expense.

$\begin{array}{c}\text{Interest amount = Bond value}\times 6\text{\% }\times \left(5÷\text{12}\text{months}\right)\\ =\$5,000,000\times 6\text{\% }\times \left(5÷\text{12}\text{months}\right)\\ =\$125,000\end{array}$

e)

To determine

Find the prevailing market rate of interest on the date that the bonds were issued and explain the same.

Explanation of Solution

6% 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.