Chapter 14, Problem 14.16P

(1)

To determine

Bonds

Bonds are a kind of interest bearing notes payable, usually issued by companies, universities and governmental organizations. It is a debt instrument used for the purpose of raising fund of the corporations or governmental agencies. If selling price of the bond is equal to its face value, it is called as par on bond. If selling price of the bond is lesser than the face value, it is known as discount on bond. If selling price of the bond is greater than the face value, it is known as premium on bond.

Straight-line amortization bond

Straight line method of amortization is a process of amortizing premium on bond or discount on bond, which allocates the same amount of interest expense in each period of interest payment.

Early Extinguishment debt

When the debt obligations are retired before its scheduled maturity date, the transactions are referred to as early extinguishment of debt. The debt is paid at the market price of the debt and for any difference between the book value of the debt with its market price, the business recognizes the gain or loss on early extinguishment of the debt.

To Prepare: The journal entry to record the issuance of the bonds.

Explanation of Solution

Prepare journal entry to record the issuance of the bonds as on 30^th June 2016.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2016		Cash (1)	383,500
June	30
		Debt Issue Costs	1,500
		Discount on Bonds Payable (2)	15,000
		Bonds Payable		400,000
		(To record the issue of bonds)

Table (1)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = Issue price of bonds – Debt issue costs}\\ \text{= \$385,000}\text{–}\text{\$1,500}\\ \text{= \$383,500}\end{array}$

Hence, cash received amount is $383,500.

(1)

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable }=\text{Bonds payable –}\text{Issue price of bonds}\\ =\$400,000-\$385,000\\ =\$15,000\end{array}$

Hence, discount on bonds payable amount is $15,000.

(2)

• Cash is an asset and it increases by $383,500. Therefore, debit cash account by $383,500.
• Debt issue cost is a contra liability and it decreases by $1,500. Therefore, debit debt issue costs account by $1,500.
• Discount on bonds payable is a contra liability and it decreases by $15,000. Therefore, debit discount on bonds payable account by $15,000.
• Bonds payable is a long-term liability and it increases by $400,000. Therefore, credit bonds payable account by $400,000.

(2)

To determine

To Prepare: The journal entry to record the payment of interest and amortization of discount.

Explanation of Solution

Prepare journal entry to record payment of interest and amortization of discount on December 31, 2016.

Date		Account Title and Explanation			Debit ($)	Credit  ($)
2016		Interest Expense (5)			20,750
December	31		Discount on Bonds Payable (4)			750
			Cash (3)			20,000
				(To record payment of interest)

Table (2)

Working notes:

Calculate the amount of interest as on December 31, 2016.

$\begin{array}{c}\text{Interest paid}\left(\text{Cash}\text{paid}\right)=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$400,000\times 10\%\times \frac{6}{12}\\ =\$20,000\end{array}$

Hence, interest paid amount is $20,000.

(3)

Calculate discount on bonds payable.

$\begin{array}{c}\text{ Discount on bonds payable }=\frac{\text{Total bond}\text{discount }}{\text{Number of discount}}\\ =\frac{\$15,000}{20}\\ =\$750\end{array}$

Hence, discount on bonds payable amount is $750.

(4)

Calculate the interest expense on the bond as on December 31, 2016.

$\begin{array}{c}\text{Interest expense}=\text{Cash}\text{paid}\text{+}\text{Discount}\text{on bonds}\text{payable}\\ =\$20,000+\$750\\ =\$20,750\end{array}$

Hence, interest expense amount is $20,750.

(5)

• Interest Expense is an expense and it decreases the value of equity. Therefore, debit interest expense account by $20,750.
• Discount on bonds payable is a contra liability and it increases by $750. Therefore, credit discount on bonds payable account by $750.
• Cash is an asset and it decreases by $20,000. Therefore, credit cash account by $20,000.

(3)

To determine

To Prepare: The journal entry to record payment of interest and amortization of discount on June 30, 2017.

Explanation of Solution

The following is the journal entry for payment of interest and amortization of discount on June 30, 2017:

Date		Account Title and Explanation			Debit ($)	Credit  ($)
2017		Interest Expense (9)			20,750
June	30		Discount on Bonds Payable (8)			750
			Cash (7)			20,000
				(To record payment of interest)

Table (4)

Working notes:

Calculate the amount of interest as on June 30, 2017.

$\begin{array}{c}\text{Interest paid}\left(\text{Cash}\text{paid}\right)=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$400,000\times 10\%\times \frac{6}{12}\\ =\$20,000\end{array}$

Hence, interest paid amount is $20,000.

(7)

Calculate discount on bonds payable.

$\begin{array}{c}\text{ Discount on bonds payable }=\frac{\text{Total bond}\text{discount }}{\text{Number of discount}}\\ =\frac{\$15,000}{20}\\ =\$750\end{array}$

Hence, discount on bonds payable amount is $750.

(8)

Calculate the interest expense on the bond as on June 30, 2017.

$\begin{array}{c}\text{Interest expense}=\text{Cash}\text{paid}\text{+}\text{Discount}\text{on bonds}\text{payable}\\ =\$20,000+\$750\\ =\$20,750\end{array}$

Hence, interest expense amount is $20,750.

(9)

• Interest Expense is an expense and it decreases the value of equity. Therefore, debit interest expense account by $20,750.
• Discount on bonds payable is a contra liability and it increases by $750. Therefore, credit discount on bonds payable account by $750.
• Cash is an asset and it decreases by $20,000. Therefore, credit cash account by $20,000.

(4)

To determine

To Prepare: The journal entry to record the call of the bonds.

Explanation of Solution

The following is the journal entry to record the call of the bonds:

Date		Accounts and Explanations	Debit ($)	Credit  ($)
2017
July	1	Bonds Payable	400,000
		Loss on Early Extinguishment of Bonds (13)	9,850
		Debt Issue Costs (12)		1,350
		Discount on Bonds Payable (11)		13,500
		Cash		395,000
		(To record early extinguishment of bonds)

Table (6)

Working notes:

Calculate the amount of discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable }=\left(\text{Bonds payable –}\text{Issue price of bonds}\right)\times \frac{9}{10}\\ =\left(\$400,000-\$385,000\right)\times \frac{9}{10}\\ =\$13,500\end{array}$

Hence, discount on bonds payable amount is $13,500.

(11)

Calculate remaining debt issue costs.

$\begin{array}{c}\text{Debt issue costs = \$1,500}\times \frac{9}{10}\\ =\$1,350\end{array}$

Hence, debt issue costs amount is $1,350.

(12)

Calculate the amount of loss on early extinguishment.

$\begin{array}{c}\text{Loss on early extinguishment = }\left(\begin{array}{l}\text{Cash paid + Discount on bonds payable}\\ \text{ +Debt issue costs– Bonds payable}\end{array}\right)\\ =\left(\$395,000+\$13,500+\$1,350-\$400,000\right)\\ =\$9,850\end{array}$

Hence, loss on early extinguishment amount is $9,850.

(13)

• Bonds payable is a liability account. The amount has decreased because the liability is paid off. Therefore, debit bonds payable account with $400,000.
• Loss on early retirement of bonds is an expense account. Loss decrease equity account. Therefore, debit loss on early retirement of bonds account with $9,850.
• Debt issue cost is a liability and it increases by $1,350. Therefore, credit debt issue costs account by $1,350.
• Discount on bonds payable is a contra liability account. The amount is increased because the carrying value of bonds payable is increased to amortize the discount. Therefore, credit discount on bonds payable account with $13,500.
• Cash is an asset account. The amount has decreased because debt is paid; therefore, credit Cash account with $395,000