Chapter 14, Problem 14.4APR

Entries for bonds payable and installment note transactions

The following transactions were completed by Winklevoss Inc., whose fiscal year is the calendar year:

2016

July 1.	Issue d $74,000,000 of 20-year, 11% callable bonds dated July 1, 2016, at a market (effective) rate of 13%, receiving cash of $63 , 532,267. Interest is payable semiannually on December 31 and June 30.
Oct. 1.	Borrowed $200,000 by issuing a six-year, 6 % installment note to Nicks Bank. The note requires annual payments of $40,673, with the first payment occurring on September 30, 2017.
Dec. 31.	Accrued $3,000 of interest on the installment note. The interest is pay able on the date of the next installment note payment.
31.	Paid the semiannual interest on the bonds. The bond discount amortization of $261,693 is combined with the semiannual interest payment.
31.	Closed the interest expense account.

2017

June 30.	Paid the semiannual interest on the bonds. The bond discount amortization of $261,693 is combined with the semiannual interest payment.
Sept. 30.	Paid the annual payment on the note, which consisted of interest of $ 12,000 and principal of $28,673.
Dec. 31.	Accrued $2,570 of interest on the installment note. The interest is payable on the date of the next installment note payment.
	31. Paid the semiannual interest on the bonds. The bond discount amortization of $261, 693 is combined with the semiannual interest payment.
	31. Closed the interest expense account.

2018

June 30.	Recorded the redemption of the bonds, which were called at 98. The balance in the bond discount account is $9,420,961 after payment of interest and amortization of discount have been recorded. (Record the redemption only.)
Sept. 30.	Paid the second annual payment on the note, which consisted of interest of $10,280 and principal of $30,393.

Instructions

1. Journalize the entries to record the foregoing transactions. Round all amounts to the nearest dollar.

2. Indicate the amount of the interest expense in (a) 2016 and (b) 2017.

3. Determine the carrying amount of the bonds as of December 31, 2017.

To determine

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.

Installment note: It is a debt in which the borrower is required to pay equal periodic payments to the lender based on the term of the note.

To Journalize: The entries to record the transactions.

Explanation of Solution

 

Journalize the entries to record the transactions.

Date	Accounts and Explanation	Post Ref.	Debit ($)	Credit ($)
2016	Cash		63,532,267
July  1	Discount on Bonds Payable (1)		10,467,733
	Bonds Payable			74,000,000
	(To record issue of bonds at discount)
October 1	Cash		200,000
	Notes Payable			200,000
	(To record issue of 6% notes for cash)
December 31	Interest Expense		3,000
	Interest Payable			3,000
	(To record interest accrued on installment note)
December 31	Interest Expense (4)		4,331,693
	Discount on Bonds Payable (2)			261,693
	Cash (3)			4,070,000
	(To record semiannual interest payment and amortization on bonds)
December 31	Income Summary		4,334,693
	Interest Expense			4,334,693
	(To close interest expense account)

Table (1)

Date	Accounts and Explanation	Post Ref.	Debit ($)	Credit ($)
2017	Interest Expense (4)		4,331,693
June 30	Discount on Bonds Payable (2)			261,693
	Cash (3)			4,070,000
	(To record semiannual interest payment and amortization on bonds)
September 30	Interest Expense		9,000
	Interest Payable		3,000
	Notes Payable		28,673
	Cash			40,673
	(To record the annual payment on note)
December 31	Interest Expense		2,570
	Interest Payable			2,570
	To record interest accrued on installment note)
December 31	Interest Expense (4)		4,331,693
	Discount on Bonds Payable (2)			261,693
	Cash (3)			4,070,000
	(To record semiannual interest payment and amortization on bonds)
December 31	Income Summary		8,674,956
	Interest Expense			8,674,956
	(To close interest expense account)

Table (2)

Date	Accounts and Explanation	Post Ref.	Debit ($)	Credit ($)
2018	Bonds Payable		74,000,000
June 30	Loss on Redemption of Bonds (6)		7,940,961
	Discount on Bonds Payable			9,420,961
	Cash (5)			72,520,000
	(To record redemption of bonds)
September 30	Interest Expense		7,710
	Interest Payable		2,570
	Notes Payable		30,393
	Cash			40,673
	(To record the annual payment on note)

Table (3)

Working notes:

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\begin{array}{l}\text{Face value }\\ -\text{ Cash received}\end{array}\right)\\ =\$74,000,000-\$63,532,267\\ =\$10,467,733\end{array}$ (1)

Calculate discount on bonds payable semiannually.

$\begin{array}{c}\begin{array}{l}\text{Discount on bonds payable }\\ \text{semiannually}\end{array})\text{=}\frac{\text{Discount}\text{on}\text{bonds}\text{payable}\text{per}\text{year}}{\text{Number}\text{of}\text{semiannual}}\\ \text{=}\frac{\$10,467,733}{40}\\ \text{=}\text{\$261,693 }\end{array}$ (2)

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$74,000,000\times 11\%\times \frac{6}{12}\\ =\$4,070,000\end{array}$ (3)

Calculate the interest expense on the bond.

$\begin{array}{c}\text{Interest expense = Cash interest + Discount on bonds payable}\\ =\$4,070,000+\$261,693\\ =\$4,331,693\end{array}$ (4)

Calculate cash paid to redeem the bonds.

$\begin{array}{c}\text{ Cash paid to redeem the bonds = Face value}\times 0.98\\ \text{= \$74,000,000}\times 0.98\\ \text{=}\text{\$72,520,000}\end{array}$ (5)

Compute loss on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Loss on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Cash paid to redeem the bonds}\\ +\text{Discount}\text{on}\text{bonds}\text{payable}\end{array}\right)–\text{Bonds payable}\\ =\$72,520,000+\$9,420,961–\$74,000,000\\ =\$7,940,961\end{array}$ (6)

2016:

• On July 1, Cash is debited as it increased the asset. Discount on bonds payable is debited as it decreased the liability. Bonds payable is credited as it increased the liability.
• On October 1, Cash is debited as it increased the asset. Notes payable is credited as it increased the liability.
• On December 31, interest expense is debited as it decreases the equity value. Interest payable is credited as it increased the liability.
• On December 31, interest expense is debited as it decreases the equity value. Discount on bonds payable is credited as it increased the liability. Cash is credited as it decreased the asset.
• On December 31, Income summary is debited and interest expense is credited due to closing of interest expense account.

2017:

• On June 30, interest expense is debited as it decreases the equity value. Discount on bonds payable is credited as it increased the liability. Cash is credited as it decreased the asset.
• On September 30, interest expense is debited as it decreases the equity value. Interest payable and notes payable are debited as it decreased the liability. Cash is credited as it decreased the asset.
• On December 31, interest expense is debited as it decreases the equity value. Interest payable is credited as it increased the liability.
• On December 31, interest expense is debited as it decreases the equity value. Discount on bonds payable is credited as it increased the liability. Cash is credited as it decreased the asset.
• On December 31, Income summary is debited and interest expense is credited due to closing of interest expense account.

2018:

• On June 30, Bonds payable is debited as it decreased liability. Loss on redemption of bonds is debited as it decreases the equity value. Discount on bonds payable is credited as it increased the liability. Cash is credited as it decreased the asset.
• On September 30, interest expense is debited as it decreases the equity value. Interest payable and notes payable are debited as it decreased the liability. Cash is credited as it decreased the asset.

To determine

The amount of interest expense in Year 2016.

Explanation of Solution

Determine the amount of interest expense in 2016.

$\begin{array}{c}\text{Total interest expense in }2016\text{ = \$3,000 +\$4,331,693}\\ \text{=}\text{\$4,334,693}\end{array}$

Conclusion

Hence, the amount of total interest expense in 2016 is $4,334,693.

To determine

Determine the amount of interest expense in 2017.

Explanation of Solution

$\begin{array}{c}\text{Total interest expense in }2017\text{ = \$4,331,693 +\$9,000 +\$2,570 + \$4,331,693}\\ \text{=}\text{\$8,674,956}\end{array}$

Conclusion

Hence, the amount of total interest expense in 2017 is $8,674,956.

To determine

  The carrying amount of bonds as of December 31, 2017.

Explanation of Solution

Determine the carrying amount of bonds as of December 31, Year 2017.

Particulars	Amount ($)
Initial carrying amount of bonds	63,532,267
Discount amortized on December 31, 2016	261,693
Discount amortized on June 30, 2017	261,693
Discount amortized on December 31, 2017	261,693
Carrying amount of bonds, December 31, 2017	64,317,346

Table (4)

Conclusion

The carrying amount of bonds as of December 31, 2017 is $64,317,346