Chapter 10, Problem 9E

a)

To determine

Prepare the journal entries to record the issuance of the bonds on April 1, 2018

Explanation of Solution

Bonds: Bonds are a kind of interest bearing notes payable, usually issued by companies, universities and governmental organizations. It is a debt instrument used for the purpose of raising fund of the corporations or governmental agencies. If selling price of the bond is equal to its face value, it is called as par on bond. If selling price of the bond is lesser than the face value, it is known as discount on bond. If selling price of the bond is greater than the face value, it is known as premium on bond.

Prepare the journal entry at April 1, 2018, to record the issuance of the bonds:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
April 1, 2018	Cash		8,160,000
	Premium on Bonds payable			160,000
	Bonds payable			8,000,000
	(To record the issuance of bonds)

Table (1)

• Cash (asset) is increased. Thus, it is debited.
• Premium on Bonds payable (liability) is increased. Thus, it is credited.
• Bonds payable (liability) is increased. Thus, it is credited.

b)

To determine

Prepare the journal entries to record the payment of interest and amortization of bond premium on September 30, 2018.

Explanation of Solution

Bond premium: Bond discount is the amount by which the selling price (or issue price or market price) of the bond is more than the face value of the bond.

Prepare the journal entries to record the payment of interest and amortization of bond premium on September 30, 2018:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
September  30, 2018	Bond Interest Expense (1)		316,000
	Premium on Bonds Payable		4,000
	Cash			320,000
	(To record the adjusting entry for the year end September  30, 2018)

Table (2)

• Bond interest expense (decreases the equity) is increased. Thus, it is debited.
• Premium on bonds payable (liability) is decreased. Thus, it is debited.
• Cash (asset) is decreased. Thus, it is credited.

Working note:

Calculate the bond interest expense:

Semi-annual interest $\left[\$8,000,000\times 8\%\times \left(6\text{months }÷\text{ 12 months}\right)\right]$	$320,000
Less: Bond premium amortized $\left(\$160,000÷20\text{years}\right)\times \left(1÷2\right)$	(4,000)
Bond Interest expense	$316,000

(1)

Table (3)

c)

To determine

Prepare the journal entries to record the payment of interest and amortization of bond premium and retire the bonds at maturity on March 31, 2038.

Explanation of Solution

Prepare the journal entries to record the payment of interest and amortization of bond premium and retire the bonds at maturity on March 31, 2038:

Date	Account title and Explanation	Post Ref.	Debit ($)	Credit ($)
March  31, 2038	Bond Interest payable		160,000
	Bond Interest Expense		158,000
	Premium on Bonds Payable		2,000
	Cash (2)			320,000
	(To record the final interest payment and amortized bond premium)
March  31, 2038	Bond payable		8,000,000
	Cash			8,000,000
	(To record the retirement of bonds)

Table (4)

To record the final interest payment and amortized bond premium:

• Bond interest payable (liability) is decreased. Thus, it is debited.
• Bond interest expense (decreases the equity) is increased. Thus, it is debited.
• Premium on bonds payable (liability) is decreased. Thus, it is debited.
• Cash (asset) is decreased. Thus, it is credited.

To record the retirement of bonds

• Bond payable (liability) is decreased. Thus, it is debited.
• Cash (asset) is decreased. Thus, it is credited.

Working notes:

Calculate the amount of cash has to be pay for the final interest payment and amortized bond premium:

Bond interest payable $\left[\$8,000,000\times 8\%\times \left(3÷\text{ 12 months}\right)\right]$	$160,000
Bond premium amortized $\left(\$160,000÷20\text{years}\right)\times \left(3÷12\text{months}\right)$	2,000
Bond interest amount $\left(\$316,000\times 3÷6\text{months}\right)$	158,000
The amount of cash has to pay for the final interest payment and amortized bond premium	$320,000

(2)

Table (5)

d)

To determine

Briefly explain the effect of amortizing the bond premium on (1) annual net income and (2) annual net cash flow from operating activities.

Explanation of Solution

The effect of amortizing the bond premium on (1) annual net income, and (2) annual net cash flows from operating activities:

1. 1) Amortizing the bond premium reduces the annual interest expense amount and this will results in increase in the annual net income.
2. 2) Amortization of bonds premium is a non cash expense, part of the annual net interest expense. Therefore, it has no effect on the annual net cash flows from operating activities.