Chapter 11, Problem 2PA

1.

To determine

Prepare journal entry to record the amount of cash proceeds from the issuance of the bonds on July 1, 20Y1.

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 high price than the face value.

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

Prepare journal entry for cash proceeds from the issuance of the bonds on July 1, 20Y1.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
20Y1		Cash				31,951,110
July	1		Premium on Bonds Payable (1)				1,951,110
			Bonds Payable				30,000,000
				(To record issue of bonds at premium)

Table (1)

• Cash is an asset and it is increased. So, debit it by $31,951,110.
• Premium on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $1,951,110.
• Bonds payable is a liability and it is increased. So, credit it by $30,000,000.

Working note (1):

Calculate premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = }\left(\begin{array}{l}\text{Cash received }\\ -\text{Face value }\end{array}\right)\\ =\$31,951,110-\$30,000,000\\ =\$1,951,110\end{array}$

2. a.

To determine

Prepare journal entry to record first semiannual interest payment and amortization of bond premium on December 31, 20Y1.

Explanation of Solution

Prepare journal entry for first semiannual interest payment and amortization of premium on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
20Y1		Interest Expense (4)				1,402,444
December	31	Premium on Bonds Payable  (2)				97,556
			Cash (3)				1,500,000
				(To record first semiannual payment of interest on bonds)

Table (2)

• Interest expense is an expense and it decreases the equity value. So, debit it by $1,402,444.
• Premium on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $97,556.
• Cash is an asset and it is decreased. So, credit it by $1,500,000.

Working note (2):

Calculate premium on bonds payable semiannually.

$\begin{array}{c}\begin{array}{l}\text{Premium on bonds payable}\\ \text{semiannually}\end{array}\}=\left(\frac{\text{Premium on bonds payable per year}}{\text{Number}\text{of}\text{semiannual payment}}\right)\\ =\frac{\$1,951,110}{20}\\ =\$97,556\end{array}$   

Working note (3):

Calculate the amount of cash paid.

$\begin{array}{c}\text{ Cash paid = }\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$30,000,000\times 10\%\times \frac{6}{12}\\ =\$1,500,000\end{array}$   

Working note (4):

Calculate the interest expense on the bond.

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Cash}\text{Paid }-\text{ Premium}onBondsPayable\\ =\$1,500,000-\$97,556\\ =\$1,402,444\end{array}$

2. b.

To determine

Prepare journal entry to record second interest payment and amortization of bond discount on June 30, 20Y2.

Explanation of Solution

Prepare journal entry for second interest payment and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
20Y2		Interest Expense (4)				1,402,444
June	30	Premium on Bonds Payable  (2)				97,556
			Cash (3)				1,500,000
				(To record second semiannual payment of interest on bonds)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $1,402,444.
• Premium on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $97,556.
• Cash is an asset and it is decreased. So, credit it by $1,500,000.

3.

To determine

Determine the amount of total interest expense for 20Y1.

Explanation of Solution

Determine the amount of total interest expense for 20Y1.

$\begin{array}{c}\text{Total interest expense for 20Y1 = }\left(\begin{array}{l}\text{ Interest paid in 20Y1}\\ -\text{Premium amortized in 20Y1}\end{array}\right)\\ =\$1,500,000-\$97,556\\ =\$1,402,444\end{array}$

Conclusion

Hence, the amount of total interest expense for 20Y1 is $1,402,444.

4.

To determine

Explain the situation when contract rate of bond is greater than the market rate of interest.

Answer to Problem 2PA

Yes, the bond proceeds will always be greater than the face amount of bonds when the contract interest rate is greater than the market interest rate.

Explanation of Solution

If the stated interest rate of a bond is greater than the market interest rate, then the bonds is issued at premium. This is because the bonds is more valuable in market and investors is ready to pay more than the maturity value of bonds.

5.

To determine

Calculate the amount of cash proceeds (present value) from the sale of the bonds using present value tables.

Explanation of Solution

Determine the amount of cash proceeds (present value) from the sale of the bonds.

Step 1: Calculate the semiannual interest on bonds.

$\begin{array}{c}\text{Interest}=\text{Face value}\times \text{Face interest rate}\times \text{Interest time period}\\ =\$30,000,000\times 10\%\times \frac{6}{12}\\ =\$1,500,000\end{array}$

Step 2: Calculate the present value of interest.

Particulars	Amount
Interest payment (a)	$1,500,000
PV annuity factor at semiannual market interest rate of 4.5% for 20 periods (b)	13.00794
Present value $\left(\text{a}\right)\text{×}\left(\text{b}\right)$	$19,511,910

Table (4)

Note: Refer Appendix A in the text book for present value annuity factor.

Step 3: Calculate the present value of lump sum payment of $30,000,000 (principal amount) at 4.5% for 20 periods.

Particulars	Amount
Single payment (a)	$30,000,000
PV factor of $1 at semiannual market interest rate of 4.5% for 20 periods (b)	0.41464
Present value $\left(\text{a}\right)\text{×}\left(\text{b}\right)$	$12,439,200

Table (5)

Note: Refer Appendix A in the text book for present value of $1 factor.

Step 4: Calculate the amount of cash proceeds from the sale of the bonds.

$\begin{array}{c}\text{Cash proceeds from sale of bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of Lump sum payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$19,511,910}\left(\text{from table 4}\right)\\ +\text{\$12,439,200}\left(\text{from table 5}\right)\end{array}\right)\\ =\text{\$31,951,110}\end{array}$

Conclusion

Thus, the amount of cash proceeds from the sale of the bonds is $31,951,110.