Chapter 12, Problem 12.6EX

a.1.

To determine

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.

Discount on bonds payable: It occurs when the bonds are issued at a low price than the face value.

To Prepare: Journal entry to record issuance of the bonds.

Explanation of Solution

Prepare journal entry for issuance of bonds payable.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
		Cash				17,138,298
		Discount on Bonds Payable  (1)				1,361,702
			Bonds Payable				18,500,00
				(To record issuance of bonds payable at discount)

Table (1)

Working note:

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\begin{array}{l}\text{Face value }\\ -\text{ Cash received}\end{array}\right)\\ =\$18,500,000-\$17,138,298\\ =\$1,361,702\end{array}$ (1)

• Cash is an asset and it is increased. So, debit it by $17,138,298.
• Discount on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $1,361,702.
• Bonds payable is a liability and it is increased. So, credit it by $18,500,000.

2.

To determine

To Prepare: Journal entry to record first interest payment and amortization of discount on bonds.

Explanation of Solution

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

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
		Interest Expense (4)				1,061,170
			Discount on Bonds Payable  (2)				136,170
			Cash (3)				925,000
				(To record semiannual payment of interest and amortization of discount on bonds)

Table (2)

Working notes:

Calculate discount on bonds payable semiannually.

$\begin{array}{c}\begin{array}{l}\text{Discount on bonds payable }\\ \text{semiannually}\end{array})\text{=}\frac{\text{Discount}\text{on}\text{bonds}\text{payable}\text{per}\text{year}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\$1,361,702}{10}\\ \text{=}\text{\$136,170}\end{array}$ (2)

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$18,500,000\times 10\%\times \frac{6}{12}\\ =\$925,000\end{array}$ (3)

Calculate the interest expense on the bond.

$\begin{array}{c}\text{Interest expense = }\left[\begin{array}{l}\text{Cash interest }\\ \text{+ Discount on bonds payable}\end{array}\right]\\ =\left[\$925,000+\$136,170\right]\\ =\$1,061,170\end{array}$ (4)

• Interest expense is an expense and it decreases the equity value. So, debit it by $1,061,170.
• Discount on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $136,170.
• Cash is an asset and it is decreased. So, credit it by $925,000.

3.

To determine

To Prepare: Journal entry to record second interest payment and amortization of discount on bonds.

Explanation of Solution

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

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
		Interest Expense (7)				1,061,170
			Discount on Bonds Payable  (5)				136,170
			Cash (6)				925,000
				(To record semiannual payment of interest and amortization of discount on bonds)

Table (3)

Working notes:

Calculate discount on bonds payable semiannually.

$\begin{array}{c}\begin{array}{l}\text{Discount on bonds payable }\\ \text{semiannually}\end{array})\text{=}\frac{\text{Discount}\text{on}\text{bonds}\text{payable}\text{per}\text{year}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\$1,361,702}{10}\\ \text{=}\text{\$136,170}\end{array}$ (5)

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$18,500,000\times 10\%\times \frac{6}{12}\\ =\$925,000\end{array}$ (6)

Calculate the interest expense on the bond.

$\begin{array}{c}\text{Interest expense = }\left[\begin{array}{l}\text{Cash interest }\\ \text{+ Discount on bonds payable}\end{array}\right]\\ =\left[\$925,000+\$136,170\right]\\ =\$1,061,170\end{array}$ (7)

• Interest expense is an expense and it decreases the equity value. So, debit it by $1,061,170.
• Discount on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $136,170.
• Cash is an asset and it is decreased. So, credit it by $925,000.

b.

To determine

The amount of bond interest expense for first year.

Explanation of Solution

Determine the amount of bonds interest expense for first year.

$\begin{array}{c}\text{Bond interest expense for first year = }\left(\begin{array}{l}\text{Annual interest paid}\\ \text{+Discount amortized in 1 year}\end{array}\right)\\ =\left[\begin{array}{l}\left(\$925,000+\$925,000\right)\\ +\left(\$136,170+\$136,170\right)\end{array}\right]\\ =\$1,850,000+\$273,340\\ =\$2,122,340\end{array}$

Conclusion

Hence, the amount of bonds interest expense for first year is $2,122,340.

c.

To determine

To Explain: The reason why the company was able to issue the bonds for $17,138,298 rather than $18,500,000.

Explanation of Solution

Company P was able to issue the bonds for $17,138,298 rather than $18,500,000 because of the following reasons:

• The market interest rate (12%) of bonds was higher than the stated interest rate of 10%.
• The bonds were less valuable in market and investors were ready to pay less than the maturity value of bonds