Chapter 14, Problem 10APSA

To determine

Issue of bond at premium:

When the coupon rate or contract rate of a bond is higher than the market interest rate, the bond is being issued at premium. If the bond is issued at premium, the selling price of the bond will be higher than the face value of the bond.

Effective interest method:

Effective interest method aims at computing an accurate interest expense. In case of issue of bonds on premium, the carrying value of the bonds payable inclusive of premium amortized is used to determine the interest expense during a particular period. Hence the interest expense decreases as the carrying value of the bonds decrease.

To determine:

1. Prepare journal entry for the issuance of bonds.

2. Compute the total bond interest expense to be recognized over the bonds’ life.

3. Preparation of amortization table for first two year using the effective interest method.

4. Prepare journal entry to record the first two interest payments.

5. Prepare journal entry to record the retirement of bonds on January 1, 2017, at 98.

6. Assume that the market rate on January 1, 2015, is 12% instead of 10%. Without presenting numbers, describe how this change affects the amounts reported on Ike’s financial statement.

Answer to Problem 10APSA

Solution:

1.

Date	Accounts	Debit	Credit
2015
Jan. 1	Cash	$184,566
	Bonds Payable		$180,000
	Premium on Bonds Payable		$4,566

2.
The total bond interest expense to be recognized over the bond’s life is $54,834.

3. Amortization Table

Period Ending	(A) Cash Interest Paid 5.5% X Par Value	(B) Bond Interest Expense 5% X Prior (E)	(C) Premium Amortization (A) − (B)	(D) Unamortized Premium Prior (D) − (C)	(E) Carrying Value Par Value + (D)
01/1/2015				$4,566	$184,566
06/30/2015	$9,900	$9,228	$672	$3,894	$183,894
12/31/2015	$9,900	$9,195	$705	$3,189	$183,189
06/30/2016	$9,900	$9,159	$741	$2,448	$182,448
12/31/2016	$9,900	$9,122	$778	$1,670	$181,670
06/30/2017	$9,900	$9,084	$816	$854	$180,854
12/31/2017	$9,900	$9,046	$854	0	$180,000
	$59,400	$54,834	$4,566

4. Journal entries to record the first two interest payments.

Date	General Journal	Debit	Credit
2015
Jun. 30	Interest Expense	$9,228
	Premium on Bonds Payable	$672
	Cash		$9,900
Dec. 31	Interest Expense	$9,195
	Premium on Bonds Payable	$705
	Cash		$9,900

5. Journal entry for the retirement of bonds payable

Date	General Journal	Debit	Credit
2017
Jan. 1	Bonds Payable	$180,000
	Premium on Bonds payable	$1,670
	Cash		$176,400
	Gain on retirement of bonds		$5,270

6.
If the market rate on January 1, 2015 is 12% instead of 10%, the issue will be on discount because the market rate exceeds the contract rate. In this case the interest expense will be more and interest payment will be lesser due to the amortization of discount semiannually.

Explanation of Solution

Explanation:

1. Computation of Premium on bonds payable

  $\begin{array}{l}\text{Premium }onBondsPayable=Issuepriceofthebond–Parvalueofthebond\hfill \\ =\$184,566-\$180,000\hfill \\ =\$4,566\hfill \end{array}$

2.

Computation of total interest expense
Amount to be repaid at maturity:
Total Interest Payment	$59,400
Par Value of Bonds	$180,000
Total amount to be repaid	$239,400
Less : Selling Price of the Bonds	$184,566
Total Bond Interest Expense	$54,834

  $\begin{array}{l}*InterestPayment=\$9,900X\text{ 6 }=\$59,400\hfill \\ *SemiannualInterestPayment=\$180,000X0.055=\$9,900\hfill \end{array}$

3.

4. The journal entry record the first two interest expense in effective interest method is basically same except the amount of interest expense and amortization per period changes.

5.

Par Value of the bonds (Dr.)	$180,000
Add: Unamortized Premium (12/31/2016)	$1,670
Carrying Value of bonds (12/31/2016)	$181,670
Less: Cash Proceeds on retirement ($180,000 X 0.98)	$176,400
Gain on retirement of bonds	$5,270

Conclusion

Conclusion:

It is concluded that the total interest expense over the life of the bonds is $54,834 and at the retirement of bonds, Ike gained a sum of $5,270.