Chapter 10, Problem 6PA

1.

To determine

Prepare a bond amortization schedule.

Explanation of Solution

Amortization Schedule: An amortization schedule is a table that shows the details of each loan payment allocated between the principal amount and the overdue interest along with the beginning and ending balance of the loan. From the amortization schedule of the loan, the periodical interest expense, total interest expense and total payment made are known.

Prepare a bond amortization schedule as below:

Bond discount amortization schedule – Straight-line Amortization Method
Year Ending December 31	Cash Paid (A) (2)	Discount Amortized (B) (3)	Interest Expense $\left(\text{C}\right)=\left(\text{A}+\text{B}\right)$	Bonds Payable (D)	Discount on Bonds Payable (E)	Carrying Value $\left(F\right)=\left(D-E\right)$
01/01/2018	–	–	–	$600,000	$16,050 (1)	$583,950
12/31/2018	$30,000	$5,350	$35,350	$600,000	$10,700	$589,300
12/31/2019	$30,000	$5,350	$35,350	$600,000	$5,350	$594,650
12/31/2020	$30,000	$5,350	$35,350	$600,000	0	$600,000

Table (1)

Working note (1):

Calculate the discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\text{Face value }-\text{ Cash received}\right)\\ =\$600,000-\$583,950\\ =\$16,050\end{array}$

Working note (2):

Calculate the amount of cash paid.

$\begin{array}{c}\text{ Cash paid = }\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$600,000\times 5\%\times 1\\ =\$30,000\end{array}$

Working note (3):

Calculate the discount amortized annually.

$\begin{array}{c}\begin{array}{l}\text{Discount amortized }\\ \text{annually}\end{array})\text{=}\frac{\text{Discount}\text{on}\text{bonds}\text{payable}\text{per}\text{year}}{\text{Number}\text{of}\text{years}}\\ \text{=}\frac{\$16,050}{3}\\ \text{=}\text{\$5,350 }\end{array}$

Note: Discount on bonds payable for each period is calculated by the following formula:

$\text{Discount on bonds payable = }\left[\begin{array}{l}\text{Previous balance of discount}\\ \text{ on bonds payable}–\text{Discount amortized}\end{array}\right]$

2.

To determine

Prepare journal entry to record the issuance of the bonds on January 1, 2018.

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.

Discount on bonds payable: It occurs when the bonds are issued at a low price than the face value.

Straight-line amortization method: It is a method of bond amortization that spreads the amount of the bond discount equally over the interest period.

Prepare journal entry for cash proceeds from the issuance of the bonds on January 1, 2018.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
January 1, 2018	Cash		538,950
	Discount on Bonds Payable (4)		16,050
	Bonds Payable			600,000
	(To record issuance of bonds payable at discount)

Table (2)

• Cash is an asset and it increases the value of assets. So, debit it by $538,950.
• Discount on Bonds Payable is an adjunct liability account and it decreases the value of liabilities. So, debit it by $16,050.
• Bonds payable is a liability and it increases the value of liabilities. So, credit it by $600,000.

Working note (4):

Calculate the discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\text{Face value }-\text{ Cash received}\right)\\ =\$600,000-\$583,950\\ =\$16,050\end{array}$

3.

To determine

Prepare journal entry to record the interest payment on December 31, 2018 and 2019.

Explanation of Solution

Prepare journal entry for payment of interest and amortization of discount on bonds on 2018.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2018	Interest Expense (7)		35,350
	Discount on Bonds Payable (5)			5,350
	Cash (6)			30,000
	(To record payment of interest and amortization of discount on bonds)

Table (3)

• Interest expense is a component of stockholder’s equity and it decreases the equity value. So, debit it by $35,350.
• Discount on Bonds Payable is an adjunct liability account and it increases the value of liabilities. So, credit it by $5,350.
• Cash is an asset and it decreases the value of assets. So, credit it by $30,000.

Working note (5):

Calculate the discount on bonds payable annually.

$\begin{array}{c}\begin{array}{l}\text{Discount amortized }\\ \text{annually}\end{array})\text{=}\frac{\text{Discount}\text{on}\text{bonds}\text{payable}\text{per}\text{year}}{\text{Number}\text{of}\text{years}}\\ \text{=}\frac{\$16,050}{3}\\ \text{=}\text{\$5,350 }\end{array}$

Working note (6):

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$600,000\times 5\%\times 1\\ =\$30,000\end{array}$   

Working note (7):

Calculate the interest expense on the bond for 2018.

$\begin{array}{c}\text{Interest expense = Cash interest + Discount on bonds payable}\\ =\$30,000+\$5,350\\ =\$35,350\end{array}$

Prepare journal entry for payment of interest and amortization of discount on bonds on 2019.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2019	Interest Expense (10)		35,350
	Discount on Bonds Payable (8)			5,350
	Cash  (9)			30,000
	(To record payment of interest and amortization of discount on bonds)

Table (4)

• Interest expense is a component of stockholder’s equity and it decreases the equity value. So, debit it by $35,350.
• Discount on Bonds Payable is an adjunct liability account and it increases the value of liabilities. So, credit it by $5,350.
• Cash is an asset and it decreases the value of assets. So, credit it by $30,000.

Working note (8):

Calculate the discount on bonds payable annually.

$\begin{array}{c}\begin{array}{l}\text{Discount amortized }\\ \text{annually}\end{array})\text{=}\frac{\text{Discount}\text{on}\text{bonds}\text{payable}\text{per}\text{year}}{\text{Number}\text{of}\text{years}}\\ \text{=}\frac{\$16,050}{3}\\ \text{=}\text{\$5,350 }\end{array}$

Working note (9):

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$600,000\times 5\%\times 1\\ =\$30,000\end{array}$   

Working note (10):

Calculate the interest expense on the bond for 2019.

$\begin{array}{c}\text{Interest expense = Cash interest + Discount on bonds payable}\\ =\$30,000+\$5,350\\ =\$35,350\end{array}$

4.

To determine

Prepare journal entry to record the interest and face value payment on December 31, 2020.

Explanation of Solution

Prepare journal entry for payment of interest and face value.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2020	Interest Expense (10)		35,350
	Bonds Payable		600,000
	Discount on Bonds Payable (8)			5,350
	Cash			630,000
	(To record the bonds are repaid with the discount)

Table (5)

• Interest expense is a component of stockholder’s equity and it decreases the equity value. So, debit it by $35,350.
• Bonds payable is a liability and it decreases the value of liabilities. So, debit it by $600,000.
• Discount on Bonds Payable is an adjunct liability account and it increases the value of liabilities. So, credit it by $5,350.
• Cash is an asset and it decreases the value of assets. So, credit it by $630,000.

5.

To determine

Prepare journal entry to record the bond retirement on January 1, 2020.

Explanation of Solution

Retirement of Bonds: The process of repaying the sale amount of bonds to bondholders at the time of maturity or before the maturity period is called as retirement of bonds. It is otherwise called as redemption of bonds.

Prepare Journal entry to record the bond retirement on January 1, 2020.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
January 1, 2020	Bonds Payable		600,000
	Discount on Bonds Payable			5,350
	Gain on Retirement of Bonds (13)			6,650
	Cash (12)			588,000
	(To record the retirement of the bonds at discount)

Table (6)

• Bonds payable is a liability and it decreases the value of liabilities. So, debit it by $600,000.
• Discount on Bonds Payable is an adjunct liability account and it increases the value liabilities. So, credit it by $5,350.
• Gain on retirement of bonds is an equity account and it increases the equity value. So, credit it by $6,650.
• Cash is an asset and it decreases the value of assets. So, credit it by $588,000.

Working note (11):

Calculate the carrying amount of bonds payable on the retirement.

$\begin{array}{c}\text{ Carrying amount of bonds payable = }\left(\text{Face value}-\text{Unamortized discount }\right)\\ =\$600,000-\$5,350\\ =\$594,650\end{array}$

Working note (12):

Calculate the cash paid to retire the bonds.

$\begin{array}{c}\text{Cash paid to retire the bonds = Bond value }\times \text{ Retired price}\\ \text{=\$600,000}\times \text{98\%}\\ \text{=\$588,000}\end{array}$

Working note (13):

Calculate the gain on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Gain on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Carrying amount }\\ \text{of bonds payable}\end{array}\right)–\left(\begin{array}{l}\text{Cash paid to retire }\\ \text{the bonds}\end{array}\right)\\ =\$594,650(11)-\$588,000(12)\\ =\$6,650\end{array}$