Chapter 10, Problem 8PB

1.

To determine

Prepare a bond amortization schedule under simplified effective interest amortization method.

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 amortization schedule – Simplified Effective- Interest Amortization Method
Period	Bonds Payable, Net (A)	Interest Expense $\left(\begin{array}{l}\text{Bonds payable}\\ \text{× }\frac{\text{4}\text{.25}}{\text{100}}\end{array}\right)$ (B)	Cash Paid $\left(\begin{array}{l}\text{Face}\text{value}\\ \text{× }\frac{\text{5}}{\text{100}}\end{array}\right)$ (C)	Interest subtracted to Bonds Payable $\left(D\right)=\left(C\right)–\left(B\right)$	Bonds Payable, Net $\left(E\right)=\left(A\right)-\left(D\right)$
01/01/2018to 12/31/2018	$102,070	$4,338	$5,000	$662	$101,408
01/01/2019to 12/31/2019	$101,408	$4,310	$5,000	$690	$100,718
01/01/2020to 12/31/2020	$100,718	$4,282 (rounded)	$5,000	$718	$100,000

Table (1)

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
	Bonds Payable			102,070
	(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.
• Bonds payable is a liability and it increases the value of liabilities. So, credit it by $102,070.

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 (2)		4,338
	Bonds Payable  (3)		662
	Cash (1)			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.
• Bonds Payable is a 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 (1):

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 (2):

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 (3):

Calculate the bonds amortized.

$\begin{array}{c}\text{Bonds amortized}=\text{Cash interest payment}–\text{ Interest Expense }\\ =\$5,000\text{ (1)}-\$4,338\text{ (2)}\\ =\$662\end{array}$

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 (5)		4,310
	Bonds Payable  (6)		690
	Cash (4)			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.
• Bonds Payable is a 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 (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.

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

Working note (6):

Calculate the premium amortized.

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

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 (7)		4,282
	Bonds Payable (refer table 1)		100,718
	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 $100,718.
• Cash is an asset and it decreases the value of assets. So, credit it by $105,000.

Working note (7):

Calculate interest expense.

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

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 (8)		100,718
	Loss on Retirement of Bonds (9)		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 $100,718.
• 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 (8):

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 (9):

Compute the loss on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Loss on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Cash paid to retire }\\ \text{the bonds}\end{array}\right)-\left(\begin{array}{l}\text{Carrying amount }\\ \text{of bonds payable}\end{array}\right)\\ =\left(\$100,000\times \frac{101}{100}\right)-\$100,718(9)\\ =\$101,000-\$100,718\\ =\$282\end{array}$