Chapter 10, Problem 9AP

a.

To determine

Prepare an amortization schedule

Explanation of Solution

Amortization of bond: The process of allocation and reduction of the discount or Discount on bonds to interest expense over the life of bonds is referred to as amortization of bonds.

Effective interest method: The process of amortization that uses fixed interest rate (effective interest rate) to amortize the Discount or discount on bonds is known to as effective interest method of amortization.

The effective amortization table for first two interest periods, showing the amortization of discount is prepared as follows:

Bonds Payable-Discount Amortization Table

(Effective Interest Method)

	Interest Paid	Interest Expense	Periodic Discount Amortized	Balance of Unamortized Discount	Ending Book Value
01/01/20XX				$31,156	$218,844
30/06/20XX	$10,000 (1)	$10,942 (2)	$942 (3)	$30,214	$219,786 (4)
12/31/20XX	$10,000 (1)	$10,989 (5)	$989 (6)	$29,225	$220,775 (7)

Table (1)

Working Notes:

Calculate interest paid on June 30 (first interest period).

$\begin{array}{c}\text{Interest paid}=\left(\begin{array}{l}\text{Face value of bonds}\times \text{Face interest rate}\\ \times \text{Semiannual interest time period}\end{array}\right)\\ =\$250,000\times \frac{8}{100}\times \frac{6}{12}\\ =\$10,000\end{array}$ (1)

Calculate interest expense on June 30 (first interest period).

$\begin{array}{c}\text{Interest expense }=\left(\begin{array}{l}\text{Ending book value }\times \text{ Effective interest rate}\\ \times \text{Semiannual interest time period}\end{array}\right)\\ =\$218,844\times \frac{10}{100}\times \frac{6}{12}\\ =\$10,942\end{array}$ (2)

Calculate Discount amortized on June 30 (first interest period).

$\begin{array}{c}\text{Discount amortized }=\text{ Interest expense }-\text{Interest paid}\\ =\$10,942-\$10,000(2)\\ =\text{ \$942}\end{array}$ (3)

Calculate ending book value on June 30 (first interest period).

$\begin{array}{c}\begin{array}{l}\text{Ending book value }\\ \text{on June 30}\end{array}\}=\left\{\begin{array}{l}\text{Ending book value on December 31}\\ \text{+ Discount amortized}\end{array}\right\}\\ =\$218,844+\$942(3)\\ =\$219,786\end{array}$ (4)

Calculate interest expense on December 31 (second interest period).

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Ending book value}\\ \times \text{Effective interest rate}\\ \times \text{Semiannual interest time period}\end{array}\right)\\ =\$219,786(4)\times \frac{10}{100}\times \frac{6}{12}\\ =\$10,989\end{array}$ (5)

Calculate Discount amortized on December 31 (second interest period).

$\begin{array}{c}\text{Discount amortized }=\text{ Interest expense }-\text{ Interest paid }\\ =\$10,989(1)-\$10,000(5)\\ =\$989\end{array}$ (6)

Calculate ending book value on December 31 (second interest period).

$\begin{array}{c}\begin{array}{l}\text{Ending book value }\\ \text{on June 30}\end{array}\}=\left\{\begin{array}{l}\text{Ending book value on December 31}\\ +\text{ Discount amortized}\end{array}\right\}\\ =\$219,786\text{ + }\$989(6)\\ =\$220,775\end{array}$ (7)

b.

To determine

Journalize the entry for the issuance of bonds on December 31.

Explanation of Solution

Prepare journal entry:

Date		Accounts Title and Explanations	Debit ($)	Credit ($)
December	31	Cash (A+))	218,844
		Discount on Bonds Payable (L–) (8)	31,156
		Bonds Payable (L+)		250,000
		(To record issue of bonds at discount)

Table (2)

• Cash is an asset account and it is increased. Therefore debit cash account by $218,844.
• Discount on Bonds Payable is a contra-liability account and it has a normal debit balance therefore, debit Discount on Bonds Payable account by $31,156.
• Bonds Payable is a liability and it is increased. Therefore credit bonds payable account by $250,000.

Working Notes:

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount}=\text{Face value of bonds – Cash received}\\ =\text{\$250,000 – \$218,844}\\ =\text{\$31,156}\end{array}$ (8)

c.

To determine

Journalize the payment of interest and discount amortization on June 30.

Explanation of Solution

Prepare journal entry:

Date		Accounts Title and Explanations	Debit ($)	Credit ($)
June	30	Bond Interest Expense (E–)	10,942
		Discount on Bonds Payable (L+)		942
		Cash (A–)		10,000
		(To record payment of interest and amortized discount on June 30)

Table (3)

• Bond Interest Expense is a component of stockholders’ equity and there is a increase in the interest expense account which decreased the stockholders’ equity. Therefore debit bond interest expense account by $10,942.
• Discount on Bonds Payable is a contra-liability account and the amount is increased because the entry is reversed to amortize the discount. Therefore, credit Discount on Bonds Payable account by $942.
• Cash is an asset and it is decreased. Therefore credit cash account by $10,000.

Note: Refer to requirement (a) for the values and calculations.

d.

To determine

Journalize the entry to record the payment of interest and discount amortization on December 31.

Explanation of Solution

Prepare journal entry:

Date		Accounts Title and Explanations	Debit ($)	Credit ($)
December	30	Bond Interest Expense (E–)	10,989
		Discount on Bonds Payable (L+)		989
		Cash (A–)		10,000
		(To record payment of interest and amortized discount on June 30)

Table (4)

• Bond Interest Expense is a component of stockholders’ equity and there is a increase in the interest expense account which decreased the stockholders’ equity. Therefore debit bond interest expense account by $10,989.
• Discount on Bonds Payable is a contra-liability account and the amount is increased because the entry is reversed to amortize the discount. Therefore, credit Discount on Bonds Payable account by $989.
• Cash is an asset and it is decreased. Therefore credit cash account by $10,000.

Note: Refer to requirement (a) for the values and calculations.