Chapter 10, Problem 7PB

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 bond amortization schedule as below:

Bond premium amortization schedule – Effective-interest amortization method
Year Ending December 31	Cash Paid (A) (2)	Interest Expense (B)	Premium Amortized $\left(C\right)=\left(A-B\right)$	Bonds Payable (D)	Premium on Bonds Payable (E)	Carrying Value $\left(F\right)=\left(D+E\right)$
01/01/2018	–	–	–	$100,000	$2,070 (1)	$102,070
12/31/2018	$5,000	$4,338	$662	$100,000	$1,408	$101,408
12/31/2019	$5,000	$4,310	$690	$100,000	$718	$100,718
12/31/2020	$5,000	$4,282 (rounded)	$718	$100,000	0	$100,000

Table (1)

Working note (1):

Calculate the premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = }\left(\begin{array}{l}\text{Cash received}\\ -\text{Face value }\end{array}\right)\\ =\$102,070-\$100,000\\ =\$2,070\end{array}$

Working note (2):

Calculate the amount of cash paid.

$\begin{array}{c}\text{ Cash paid = }\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$100,000\times \frac{5}{100}\times \frac{12}{12}\\ =\$5,000\end{array}$

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

$\text{Premium on bonds payable = }\left[\begin{array}{l}\left(\begin{array}{l}\text{Previous balance of}\\ \text{ premium on bonds payable}\end{array}\right)-\\ \text{ Premium amortized}\end{array}\right]$

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.

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

Effective-interest amortization method: Effective-interest amortization method it is an amortization model that apportions the amount of bond discount or premium based on the market interest rate.

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		102,070
	Premium on Bonds Payable (3)			2,070
	Bonds Payable			100,000
	(To record the issuance of bonds payable at discount)

Table (2)

• Cash is an asset and it increases the value of assets. So, debit it by $102,070.
• Premium on Bonds Payable is an adjunct liability account and it increases the value of liabilities. So, credit it by $2,070.
• Bonds payable is a liability and it increases the value of liabilities. So, credit it by $100,000.

Working note (3):

Calculate the premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = }\left(\begin{array}{l}\text{Cash received}\\ -\text{Face value }\end{array}\right)\\ =\$102,070-\$100,000\\ =\$2,070\end{array}$

3.

To determine

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

Explanation of Solution

Prepare journal entry to record the payment of interest and amortization of premium on bonds at December 31, 2018.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2018	Interest Expense (5)		4,338
	Premium on Bonds Payable  (6)		662
	Cash (4)			5,000
	(To record the payment of interest and amortization of premium on bonds)

Table (3)

• Interest expense is a component and it decreases the equity value. So, debit it by $4,338.
• Premium on Bonds Payable is an adjunct liability account and it decreases the value of liabilities. So, debit it by $662.
• Cash is an asset and it decreases the value of assets. So, credit it by $5,000.

Working note (4):

Calculate the cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$100,000\times \frac{5}{100}\times 1\text{ year}\\ =\$5,000\end{array}$

Working note (5):

Calculate the interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\$102,070\times \frac{4.25}{100}\times 1\text{ year}\\ =\$4,338\end{array}$

Working note (6):

Calculate the premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000\text{ (5)}-\$4,338\text{ (5)}\\ =\$662\end{array}$

Prepare journal entry to record the payment of interest and amortization of premium on bonds at December 31, 2019.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2019	Interest Expense (8)		4,310
	Premium on Bonds Payable  (9)		690
	Cash (7)			5,000
	(To record the payment of interest and amortization of premium on bonds)

Table (4)

• Interest expense is a component and it decreases the equity value. So, debit it by $4,310.
• Premium on Bonds Payable is an adjunct liability account and it decreases the value of liabilities. So, debit it by $690.
• Cash is an asset and it decreases the value of assets. So, credit it by $5,000.

Working note (7):

Calculate the cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$100,000\times \frac{5}{100}\times 1\text{ year}\\ =\$5,000\end{array}$

Working note (8):

Calculate the interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$102,070-\$662\right)\times \frac{4.25}{100}\times 1\text{ year}\\ =\$4,310\end{array}$

Working note (9):

Calculate the premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000(7)-\$4,310(8)\\ =\$690\end{array}$

4.

To determine

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

Explanation of Solution

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

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2020	Interest Expense (11)		4,282
	Bonds Payable		100,000
	Premium on Bonds Payable (12)		718
	Cash			105,000
	(To record the payment of interest and face value)

Table (5)

• Interest expense is a component of stockholder’s equity and it decreases the equity value. So, debit it by $4,282.
• Bonds payable is a liability and it decreases the value of liabilities. So, debit it by $100,000.
• Premium on Bonds Payable is an adjunct liability account and it decreases the value of liabilities. So, debit it by $718.
• Cash is an asset and it decreases the value of assets. So, credit it by $105,000.

Working note (10):

Calculate the cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$100,000\times \frac{5}{100}\times 1\text{ year}\\ =\$5,000\end{array}$

Working note (11):

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$102,070-\$662-\$690\right)\times \frac{4.25}{100}\times 1\text{ year}\\ =\$4,282\end{array}$

Working note (12):

Calculate premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000(10)-\$4,282(11)\\ =\$718\end{array}$

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		100,000
	Premium on Bonds Payable (14)		718
	Loss on Retirement of Bonds		282
	Cash			101,000
	(To record the retirement of the bonds)

Table (6)

• Bonds payable is a liability and it decreases the value of liabilities. So, debit it by $100,000.
• Premium on Bonds Payable is an adjunct liability account and it decreases the value of liabilities. So, debit it by $718.
• Loss on retirement of bonds is a component of stockholder’s equity and it decreases the equity value. So, debit it by $282.
• Cash is an asset and it decreases the value of assets. So, credit it by $101,000

Working note (13):

Calculate the carrying amount of bonds payable on the retirement.

$\begin{array}{c}\text{ Carrying amount of bonds payable = }\left(\begin{array}{l}\text{Face value }\\ \text{+Unamortized premium }\end{array}\right)\\ =\$100,000+\$718\\ =\$100,718\end{array}$

Working note (14):

Compute the loss on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Loss on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Cash paid to retire }\\ \text{the bonds}\end{array}\right)-\left(\begin{array}{l}\text{Carrying amount }\\ \text{of bonds payable}\end{array}\right)\\ =\left(\$100,000\times \frac{101}{100}\right)-\$100,718(13)\\ =\$101,000-\$100,718\\ =\$282\end{array}$