Chapter 10, Problem 5PSA

To determine

Bonds:

Bonds are a kind of the security which an investor invests in an entity for a specific period at a fixed interest rate. These bonds are issued at that time when entity needs huge amount of fund.

1.

To prepare: Journal entry to record the bonds’ issuance.

Explanation of Solution

Issue of bonds at discount on January 1, 2017

Date	Account Title and Explanation	Post.Ref.	Debit($)	Credit($)
Jan 1	Cash		292,181
	Discount on bonds payable		32,819
	Bonds payable			325,000
	(To record the sold bonds at discount)

Table (1)

• Cash account is the assets account. Since the cash is received, the value of assets is increased. So, debit the credit the cash account.
• Discount on bonds payable account is the liabilities account. Here, at the time of issue of the bonds discount has been given which decrease the liabilities of the company. So, debit the discount on bonds payable account.
• Bonds payable account is the liabilities account. Bonds has been sold, which increases the liabilities of the company. So, credit the bonds payable account.

Working Notes:

Given,

Value of bonds is $325,000.

Market value of bonds is $292,181.

Calculate the amount of the discount on bonds payable,

$\begin{array}{c}\text{Discount}\text{on}\text{bonds}=\text{Value}\text{of}\text{bond}-\text{Market}\text{value}\text{of}\text{bond}\\ =\$325,000-\$292,181\\ =\$32,819\end{array}$

2.

To determine

Net expense of interest on bond.

Explanation of Solution

Particulars	Amounts($)
Amount repaid:
Interest payment	65,000
Add: Maturity value	325,000
Repaid amount	390,000
Less: Borrowed amount	292,181
Net expense of interest on bond	97,819

Table (2)

Hence, net expense interest on bond is $97,819.

Working notes:

Given,

Value of bond is $325,000.

Rate of interest is 5%.

Time period is 0.5.

Calculation of amount of the interest paid at semiannual period,

$\begin{array}{c}\text{Interest}\text{amount}=\text{Value}\text{of}\text{the}\text{bond}\times \text{Rate}\text{of}\text{interest}\times \text{Time}\text{period}\\ =\text{\$325,000}\times \text{5\%}\times \text{0}\text{.5}\\ =\text{\$8,125}\end{array}$

Calculation of amount of interest repaid,

$\begin{array}{c}\text{Interest}\text{payment}=\text{Interest}\text{semiannual}\text{amount}\times \text{Number}\text{of}\text{payment}\text{period}\\ =\$8,125\times 8\\ =\$65,000\end{array}$

3.

To determine

First two year of an amortization table.

Explanation of Solution

End of semiannual period	UnamortizedDiscount ($)	Carrying value ($)
January 1, 2017	32,819	292,181
June 30, 2017	28,717	292,283
December 31, 2017	24,615	300,385
June 30 ,2018	20,513	304,487
December 31, 2018	16,411	308,589

Table (3)

Hence, unamortized discount on December 31, 2018 is $16,411 and carrying value account is $308,589.

4.

To determine

To prepare: Journal entry to record the first two interest payment.

Explanation of Solution

Payment of interest on June 30, 2017

Date	Account Title and Explanation	Post.Ref.	Debit($)	Credit($)
June 30	Bonds interest expense		12,227
	Discount on bonds payable			4,102
	Cash			8,125
	(To record the paid semiannual interest and record amortization)

Table (4)

• Bonds interest account is an expense account. Interest has been paid by the company which increases the liabilities of the company. So, debit the bonds interest expense account
• Discount on bonds payable account is the liabilities account. Here, at the time of issue of the bonds discount has been given which increases the liabilities of company. So, credit the discount on bonds payable account.
• Cash is an asset account. Since the cash is paid, the value of assets is decreased. So, credit the cash account.

Payment of interest on December 31, 2017

Date	Account Title and Explanation	Post.Ref.	Debit($)	Credit($)
Dec 31	Bonds interest expense		12,227
	Discount on bonds payable			4,102
	Cash			8,125
	(To record the paid semiannual interest and record amortization)

Table (5)

• Bonds interest account is an expense account. Interest has been paid by the company which increases the liabilities of the company. So, debit the bonds interest expense account.
• Discount on bonds payable account is the liabilities account. Here, at the time of issue of the bonds discount has been given which increases the liabilities of company. So, credit the discount on bonds payable account.
• Cash is an asset account. Since the cash is paid, the value of assets is decreased. So, credit the cash account.

5.

To determine

Change affect the amount reported on legacy’s financial statement.

Explanation of Solution

• If the bonds are issued at the 4% instead of the 8%, then bonds will be issued at premium. As the rate of interest on account for 5% which is more than rate of return in the new market.
• The change in the market rate of interest increases the bond liability of the company in the balance sheet. But, the bond liability decreases gradually with amortization of the premium.
• In this case, the cash flow statement will show greater amount pertain to receipt of the cash during the year under the borrowing head.

Working note:

Given,

Total discount on bonds payable is $32,819.

Number of payment is 8.

Calculation of discount on bond payable on the first two bond expense,

$\begin{array}{c}\text{Discount}\text{on}\text{bond}\text{payable}=\frac{\text{Total}\text{discount}\text{on}\text{bond}\text{payable}}{\text{Number}\text{of}\text{payment}}\\ =\frac{\$32,819}{8}\\ =\$4,102\end{array}$