Chapter 14, Problem 10PSB

Sub Part-1

To determine

Bonds Issuance:

The Bonds issuance by the company is a source of long term financing and is issued at a discount or premium depending the prevailing market rate of interest and stated rate of interest on bonds. When the stated rate of interest is higher than the market rate of interest, then the investors will be ready to invest only in the situation when the bonds are issued at premium. This premium on bonds issue shall be treated as income by deducting the amortized portion from the cash interest paid to arrive at the interest expense of the period.

The Journal entry for the issuance of bonds.

To determine

The Total interest expenses over the life of bonds.

Sub Part-3

To determine

Effective Interest Method of Amortization of premium:

The Effective Interest method of amortization of premium is a technique of writing off the total premium over a period of bonds by computing the premium amortized in each period after deducting the interest expense of each period at market rate from cash interest paid in each period at stated rate.

Amortization table:

The amortization table under straight line method reflects the discount amortized at each interest period, cash interest paid, total interest expense of each period, unamortized discount left at the end of period and carrying value of bonds in the books.

The Amortization table shall be prepared.

Sub Part-4

To determine

Accounting treatment of interest payment and amortized Premium:

The Accounting entry required to be passed at each interest period is debiting the total interest expense as per amortization chart and also, Premium on bonds payable is debited for the amount of premium amortized and credit being made to the cash account for cash interest paid.

The Journal entries for two interest payments.

Sub Part5.

To determine

Relation of issue price with market rate of interest and Stated rate of interest.

The contract rate of interest is interest which is offered to the investors of bonds which may be more or less than the market rate of interest prevailed. If the market rate of interest is higher than the contract rate or stated rate, then the investors will get lower return on investment as compared as market return. In this case, they will invest in the bonds only when the bonds are issued at a price less than nominal value.

However, when the market rate of interest is lower than stated rate, then the investors are ready to pay more for the bonds than nominal value as they will earn more returns on investment.