Chapter 10, Problem 7AP

a.

To determine

Prepare a journal entry to record the issuance of the bonds with accrued interest.

Explanation of Solution

Journal:

Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Journalize the entry for the issue of bonds:

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Year 1	Cash  (2)	518,750
May 1	Bonds payable		500,000
	Interest Payable (1)		18,750
	(To record 9%, $500,000 bonds at face value with accrued interest.)

Table (1)

• Cash is an asset and it is increased. Therefore cash is debited by $518,750.
• Bonds payable is a liability and it is increased. Therefore credit bonds payable account by $500,000.
• Interest payable is a liability and it is increased. Therefore credit interest payable account by $18,750.

Calculate the accrued interest as of October 1:

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 9\%\times \frac{5}{12}\\ =\$18,750\end{array}$

Note: Interest time period = 5 months (May 1 to October 1)

(1)

Calculate the amount of cash received from the issue of bonds with accrued interest:

Particulars	Amount
Face value	$500,000
Add: Accrued interest	$18,750 (1)
Cash received with accrued interest	$518,750

Table (2)

(2)

b.

To determine

Record the payment of semiannual interest on November 1 in the journal entry.

Explanation of Solution

Journalize the entry for the payment of semiannual interest on November 1:

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Year 1	Interest Expense (3)	3,750
November 1	Interest Payable	18,750
	Cash (4)		22,500
	(To record payment of semiannual interest.)

Table (3)

• Interest Expense is a component of stockholders’ equity and there is an increase in the interest expense account which decreased the stockholders’ equity. Therefore debit interest expense account by $3,750.
• Interest payable is a liability and it is decreased. Therefore debit interest payable account by $18,750.
• Cash is an asset and it is decreased. Therefore credit cash account by $22,500.

Working note:

Calculate the interest expense for October:

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 9\%\times \frac{1}{12}\\ =\$3,750\end{array}$

Note: Interest time period = 1 month (October 1 to November 1)

(3)

Calculate the amount of cash to be for the first semiannual interest:

Particulars	Amount
Interest Payable	$18,750 (1)
Add: Interest Expense	$3,750 (2)
Cash received with accrued interest	$22,500

Table (4)

(4)

c.

To determine

Prepare a journal entry to record the accrued interest expense on December 31, year 1.

Explanation of Solution

Journalize the entry to record the journal entry for interest accrual on December 31:

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Year 1	Interest Expense (5)	7,500
December 31	Interest Payable		7,500
	(To record accrual of interest expense.)

Table (5)

• Interest Expense is a component of stockholders’ equity and there is an increase in the interest expense account which decreased the stockholders’ equity. Therefore debit interest expense account by $7,500.
• Interest payable is a liability and it is increased. Therefore credit interest payable account by $7,500.

Working Notes:

Calculate the amount of interest as on December 31, 2011.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 9\%\times \frac{2}{12}\\ =\$7,500\end{array}$

Note: Interest time period = 2 months (November 1 to December 31)

(5)

d.

To determine

Prepare journal entry to record the payment of semiannual interest on May 1, Year 2.

Explanation of Solution

Journalize the entry to record the journal entry for payment of semiannual interest on 1:

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Year 2	Interest Expense (6)	15,000
May 1	Interest Payable	7,500
	Cash		22,500
	(To record payment of semiannual interest.)

Table (6)

• Interest Expense is a component of stockholders’ equity and there is an increase in the interest expense account which decreased the stockholders’ equity. Therefore debit interest expense account by $15,000.
• Interest payable is a liability and it is decreased. Therefore debit interest payable account by $7,500.
• Cash is an asset and it is decreased. Therefore credit cash account by $22,500

Working Notes:

Calculate the amount of interest as on May 1, Year 2:

$\begin{array}{c}\text{Interest expense}=\text{Face value}\times \text{Face interest rate}\times \text{Interest time period}\\ =\$500,000\times 9\%\times \frac{4}{12}\\ =\$15,000\end{array}$

Note: Interest time period = 4 months (December 31 May 1)

(6)

e.

To determine

Prepare the journal entry for the retirement of bonds payable before maturity.

Explanation of Solution

Record the journal entry:

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Year 2	Bonds Payable	300,000
May 1	Loss on Retirement of Bonds Payable (7)	3,000
	Cash		303,000
	(To record 9%, $500,000 bonds at face value with accrued interest.)

Table (7)

• Bonds Payable is a liability and it is decreased. Therefore debit bonds payable account by $300,000.
• Loss on Retirement of Bonds Payable is a component of stockholders equity and there is an increase in the loss on retirement of bonds payable which decreases the stockholders’ equity account. Therefore debit loss on retirement of bonds payable account by $3,000.
• Cash is an asset account and it is decreased. Therefore credit cash account by $303,000.

Working note:

Calculate the loss on retirement of bonds payable:

Particulars	Amount
Cash to be paid at the time of bond retirement	$303,000
Face value of bonds retired	$300,000
Loss on Retirement of Bonds Payable	$3,000

Table (8)

(7)