Chapter 10, Problem 9BE

(a)

To determine

Prepare journal entry for the issuance of bonds at premium.

Explanation of Solution

Bonds: Bonds are long-term promissory notes that are issued by a company while borrowing money from investors 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.

Prepare the following journal entry to record in the books of Company K:

Date		Accounts title and Explanations	Debit ($)	Credit ($)
2009
December	31	Cash	446,372
		Bonds Payable		400,000
		Premium on Bonds Payable (1)		46,372
		(To record issue of bonds at premium)

Table (1)

• Cash is an asset account and it is increased. Therefore debit cash account by $446,372.
• Bonds Payable is a liability and it is increased. Therefore credit bonds payable account by $400,000.
• Premium on Bonds Payable is an adjunct account and it has a normal credit balance; therefore, credit Premium on Bonds Payable account by $46,372.

Working Notes:

Calculate premium on bonds payable.

$\begin{array}{c}\text{Premium }=\text{ Cash received}–\text{Face value of bonds}\\ =\text{\$446,372 – \$400,000}\\ =\text{\$46,372}\end{array}$ (1)

(b)

To determine

Journalize the payment of interest and amortization of premium on bonds on June 30, 2010.

Explanation of Solution

Prepare the following journal entry to record in the books of Company K:

Date		Accounts title and Explanations	Debit ($)	Credit ($)
2010
June	30	Bond Interest Expense (2)	22,319
		Premium on Bonds Payable (3)	3,681
		Cash		26,000
		(To record the payment of interest and amortization of premium)

Table (2)

• Interest Expense is a component of stockholders equity. There is an increase in the expense account which decreased the stockholders’ equity. Therefore, debit interest expense account by $22,319.
• Premium on Bonds payable is a contra liability account. The amount is decreased since the premium is amortized therefore; debit Premium on Bonds Payable account by $3,681.
• Cash is an asset account and it is decreased. Therefore credit cash account by $26,000.

Working Notes:

Calculate amount of interest payable.

$\begin{array}{c}\text{Interest payable }=\text{Face value of bonds}\times \text{Interest rate}\times \text{Time period}\\ =\text{\$400,000 ×}\frac{13}{\text{100}}\times \frac{6}{12}\\ =\text{\$26,000}\end{array}$ (1)

Note: Time period = 6 months (December 31, 2009 to June 30, 2010)

Calculate amount of interest expense.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Carrying value of bonds}\\ \times \text{Market interest rate}\\ \times \text{Time period}\end{array}\right)\\ =\text{\$446,372 }\times \frac{10}{\text{100}}\times \frac{6}{12}\\ =\text{\$22,319}\end{array}$ (2)

Note: Market interest rate = 10%

Calculate premium amortized.

$\begin{array}{c}\text{Premium amortized}=\text{Interest payable – Interest expense}\\ =\text{ \$26,000 (1) – \$22,319}(2)\\ =\text{ \$3,681}\end{array}$ (3)

(c)

To determine

Journalize the payment of interest and amortization of premium on bonds on December 31, 2010.

Explanation of Solution

Prepare the following journal entry to record in the books of Company K:

Date		Accounts title and Explanations	Debit ($)	Credit ($)
2010
December	31	Bond Interest Expense (5)	22,135
		Premium on Bonds Payable (7)	3,865
		Cash		26,000
		(To record the payment of interest and amortization of premium)

Table (3)

• Bond Interest Expense is a component of stockholders’ equity. There is an increase in the expense account which decreased the stockholders’ equity. Therefore, debit Bond expense account by $22,135.
• Premium on Bonds payable is a contra liability account. The amount is decreased; since the premium is amortized, therefore, debit Premium on Bonds Payable account by $3,865.
• Cash is an asset account and it is decreased. Therefore credit cash account by $26,000.

Working Notes:

Calculate the carrying value of the bond as on June 30, 2010.

$\begin{array}{c}\begin{array}{l}\text{Carrying value as }\\ \text{on June 30, 2010}\end{array}\}=\left\{\begin{array}{l}\text{Carrying value on December 31, 2009 }\\ -\text{Amortized bond premium}\end{array}\right\}\\ =\$446,372-\$3,681\\ =\$442,691\end{array}$ (4)

Calculate the interest expense on the bond as on December 31, 2010.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Carrying value}\times \text{Market interest rate}\\ \times \text{Time period}\end{array}\right)\\ =\text{\$442,691 (4)}\times \frac{10}{\text{100}}\times \frac{6}{\text{12}}\\ =\text{\$22,135}\end{array}$ (5)

Note: Market interest rate = 10%

Calculate the amount of interest payable as on December 31, 2010.

$\begin{array}{c}\text{Interest payable }=\left(\begin{array}{l}\text{Face value of bonds }\times \text{ Interest rate}\\ \times \text{Time period}\end{array}\right)\\ =\$400,000\times \frac{13}{100}\times \frac{6}{12}\\ =\$26,000\end{array}$ (6)

Note: Interest time period = 6 months (June 30, 2010 to December 31, 2010)

Calculate amortized bond premium as on December 31, 2010.

$\begin{array}{c}\text{Amortized bond premium}=\text{Interest payable}-\text{Interest expense}\\ =\$26,000(6)-\$22,135(5)\\ =\$3,865\end{array}$ (7)