Chapter 10, Problem 9P

1.

To determine

Calculate the issue price of the bonds on January 1, 2014.

Explanation of Solution

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.

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

Straight-line amortization method: It is a method of bond amortization that spreads the amount of the bond discount or bond premium equally over the interest period.

Present Value: The current value of an amount that is to be paid or received in future is called as present value.

Determine the issue price of the bonds.

Step 1: Calculate the cash interest payment for bonds.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 10\%\times \frac{1}{2}\\ =\$100,000\end{array}$

Step 2: Calculate the present value of cash interest payment.

Particulars	Amount
Interest payment (a)	$100,000
PV factor at annual market interest rate of 4% for 20 periods (b)	13.5903
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$1,359,030

Table (1)

Note: The present value factor for 20 periods at 4% interest would be 13.5903 (Refer Appendix A (Table A.2) in the book for present value factor).

Step 3: Calculate the present value of single principal payment of $2,000,000 (principal amount) at 4% for 20 periods.

Particulars	Amount
Single principal payment (a)	$2,000,000
PV factor at annual market interest rate of 4% for 20 periods (b)	0.4564
Present value $\left(\text{a}\right)\times \left(\text{b}\right)$	$912,800

Table (2)

Note: The present value factor for 20 periods at 4% interest would be 0.4564 (Refer Appendix A (Table A.1) in the book for present value factor).

Step 4: Calculate the issue price of the bonds.

$\begin{array}{c}\text{Issue price of the bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of single principal payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$1,359,030}\left(\text{from table 1}\right)\\ +\text{\$912,800}\left(\text{from table 2}\right)\end{array}\right)\\ =\text{\$2,271,830}\end{array}$

Conclusion

Hence, the issue price of the bonds on January 1, 2014 is $2,271,830.

2.

a.

To determine

Calculate the amount of interest expense that should be recorded on June 30, 2014.

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.

Interest Expense: The cost of debt which is occurred during a particular period of time is called interest expense. The interest amount is payable on the principal amount of debt at a fixed interest rate.

Calculate the amount of interest expense that that should be recorded on June 30, 2014.

Step 1: Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 10\%\times \frac{1}{2}\\ =\$100,000\end{array}$

Step 2: Calculate premium on bonds payable, semiannually.

$\begin{array}{c}\begin{array}{l}\text{Premium on bonds payable, }\\ \text{semiannually }\end{array})\text{=}\frac{\text{Total bond Premium}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\left(\$2,271,830-\$2,000,000\right)}{20}\\ \text{=}\text{\$13,592 }\end{array}$

Step 3: Calculate interest expense.

$\begin{array}{c}\text{Interest Expense}=\text{Cash interest payment}-\text{Bond premium }\\ =\$100,000-\$13,592\\ =\$86,408\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on June 30, 2014 is $86,408.

b.

To determine

Calculate the amount of interest expense that should be recorded on December 31, 2014.

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.

Interest Expense: The cost of debt which is occurred during a particular period of time is called interest expense. The interest amount is payable on the principal amount of debt at a fixed interest rate.

Step 1: Calculate cash interest payment.

$\begin{array}{c}\text{Cash interest payment}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 10\%\times \frac{1}{2}\\ =\$100,000\end{array}$

Step 2: Calculate premium on bonds payable, semiannually.

$\begin{array}{c}\begin{array}{l}\text{Premium on bonds payable, }\\ \text{semiannually }\end{array})\text{=}\frac{\text{Total bond Premium}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\left(\$2,271,830-\$2,000,000\right)}{20}\\ \text{=}\text{\$13,592 }\end{array}$

Step 3: Calculate interest expense.

$\begin{array}{c}\text{Interest Expense}=\text{Cash interest payment}-\text{Bond premium }\\ =\$100,000-\$13,592\\ =\$86,408\end{array}$

Conclusion

Hence, amount of interest expense that should be recorded on December 31, 2014 is $86,408.

3.

a.

To determine

Calculate the amount of cash interest that should be paid on June 30, 2014.

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.

Calculate the amount of cash interest that should be paid on June 30, 2014.

$\begin{array}{c}\text{Cash interest paid}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 10\%\times \frac{1}{2}\\ =\$100,000\end{array}$

Conclusion

Hence, amount of cash interest that should be paid on June 30, 2014 is $100,000.

b.

To determine

Calculate the amount of cash interest that should be paid on December 31, 2014.

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.

Calculate the amount of cash interest that should be paid on December 31, 2014.

$\begin{array}{c}\text{Cash interest paid}=\text{Face value}\times \text{Coupon rate}\times \text{Interest time period}\\ =\$2,000,000\times 10\%\times \frac{1}{2}\\ =\$100,000\end{array}$

Conclusion

Hence, amount of cash interest that should be paid on December 31, 2014 is $100,000.

4.

a.

To determine

Calculate the book value of the bonds on June 30, 2014.

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.

Determine the book value of the bonds on June 30, 2014.

$\begin{array}{c}\text{Book value of bond on June 30 =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ -\text{Premium amortized on June 30}\end{array}\right)\\ =\$2,271,830-\$13,592\\ =\$2,258,238\end{array}$

Conclusion

Hence, the book value of the bonds on June 30, 2014 is $2,258,238.

b.

To determine

Calculate the book value of the bonds on December 31, 2014.

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.

Determine the book value of the bonds on December 31, 2014.

$\begin{array}{c}\text{Book value of bond on December 31 =}\left(\begin{array}{l}\text{Beginning book value of bonds}\\ -\text{Premium amortized on June 30}\\ -\text{Premium amortized on December 31}\end{array}\right)\\ =\$2,271,830-\$13,592-\$13,592\\ =\$2,244,646\end{array}$

Conclusion

Hence, the book value of the bonds on December 31, 2014 is $2,244,646.