Chapter 14, Problem 14.7E

(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.

To Determine: The price of the bonds for Incorporation UF as on 1^st January 2016.

Explanation of Solution

Calculation of price of the bonds for the Incorporation UF as on 1^st January 2016 as shown below:

$\begin{array}{c}\text{Price of the bonds =}\left(\begin{array}{l}\text{Present value of the principal +}\\ \text{ Present value of the interest payments}\end{array}\right)\\ =\$26,116,500+\$103,236,225\\ =\$129,352,725\end{array}$

Therefore, price of the bonds for the Incorporation UF as on 1^st January 2016 is $129,352,725.

Working notes:

Calculation of present value of interest payments of Incorporation UF as shown below:

Particulars	Amount ($)
Interest payments amount (a)	$7,500,000
PV factor at an annual market rate of 6% for 20 periods (b)	$\times$13.76483
Present value of interest payments $\left(\text{a}\right)\text{×}\left(\text{b}\right)$	$103,236,225

Table (1)

Note: The Present value of an ordinary annuity of $1 for 30 periods at 6% is 13.76483 (refer Table 4 in Appendix).

Hence, present value of interest payment of Incorporation UF is $103,236,225.

Calculation of present value of principal of Incorporation UF as shown below:

Particulars	Amount ($)
Face value of bonds (a)	$150,000,000
PV factor at an annual market rate of 6% for 20 periods (b)	$\times$ 0.17411
Present value of face value of the bonds $\left(\text{a}\right)\text{×}\left(\text{b}\right)$	$26,116,500

Table (2)

Note: The present value of $1 for 20 periods at 6% is 0.17411 (refer Table 2 in Appendix).

Hence, present value of principal amount of Incorporation UF is $26,116,500.

Calculation of the amount of interest payment as shown below:

$\begin{array}{c}\text{Interest payment}=\text{Face value of bonds}\times \text{ interest rate}\\ =\$150,000,000\times \frac{5}{100}\\ =\$7,500,000\end{array}$

Hence, the interest payment amount is $7,500,000.

Explanation:

The price of the bond is calculated by adding present value of principal and present value of interest payments. Therefore, price of the bonds for Incorporation UF is $103,236,

(2)

To determine

To Prepare: The journal entry to record the issuance of the bonds for Incorporation UF as son 1^st January 2016.

Explanation of Solution

Record the journal entry to issuance of the bonds for Incorporation UF as son 1^st January 2016 as shown below:

Record the journal entry for issuance of bonds on January 1, 2016:

Date		Account Title and Explanation	Debit ($)	Credit ($)
2016		Cash	129,352,725
January	1
		Discount on Bonds Payable	20,647,275
		Bonds Payable		150,000,000
		(To record the issue of bonds for Incorporation UF)

Table (3)

Working note:

Calculation of the discount on bonds payable as shown below:

$\begin{array}{c}\text{Discount on bonds payable }=\text{Bonds payable –}\text{Cash received}\\ =\$150,000,000-\$129,352,725\\ =\$20,647,275\end{array}$

Hence, discount on bonds payable amount is $20,647,275.

• Cash is an asset and it increases by $129,352,725. Therefore, debit cash account by $129,352,725.
• Discount on bonds payable is a contra liability and it decreases by $20,647,275. Therefore, debit discount on bonds payable account by $20,647,275.
• Bonds payable is a long-term liability and it increases by $150,000,000. Therefore, credit bonds payable account by $150,000,000.

(3)

To determine

To Prepare: The journal entry to record interest expenses as on June 30, 2016.

Explanation of Solution

Record the journal entry for payment of semiannual interest and amortization of discount on bonds issued on June 30, 2016:

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Interest Expense				8,188,243
June	30		Discount on Bonds Payable				688,243
			Cash				7,500,000
				(To record payment of semi-annual interest expenses)

Table (4)

Working notes:

Determine the amount of amortization of bond discount as shown below:

$\begin{array}{c}\text{Amortization of bond discount }=\frac{\text{Total bond}\text{discount }}{\text{Number of discount}}\\ =\frac{\$20,647,275}{30}\\ =\$688,243\end{array}$

Hence, the discount amortization of bond amount is $688,243.

Calculation of the amount of interest as on June 30, 2016 as shown below:

$\begin{array}{c}\text{Interest payable}\left(\text{Cash}\text{paid}\right)=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$150,000,000\times 10\%\times \frac{6}{12}\\ =\$7,500,000\end{array}$

Hence, interest payable (cash paid) amount is $7,500,000.

Calculation of the interest expense on the bond as on June 30, 2016 as shown below:.

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Interest payable}\text{+}\text{Discount}onBondsPayable\\ =\$7,500,000+\$688,243\\ =\$8,188,243\end{array}$

Hence, interest expenses amount is $8,188,243.

• Interest Expense is a component of stockholders’ equity, and decreased it. Therefore, debit interest expense account by $8,188,243.
• Discount on bonds payable is a contra liability and it increases by $688,243. Therefore, credit discount on bonds payable account by $688,243.
• Cash is an asset and it decreases by $7,500,000. Therefore, credit cash account by $7,500,000.

(4)

To determine

To Prepare: The journal entry to record interest expense on December 31, 2023.

Explanation of Solution

Record the journal entry for payment of semiannual interest and amortization of discount on bonds issued on December 31, 2023:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2023		Interest Expense			8,188,243
December	31		Discount on Bonds Payable			688,243
			Cash			7,500,000
				(To record payment of semi-annual interest)

Table (5)

Working notes:

Determine the amount of amortization of bond discount as shown below:

$\begin{array}{c}\text{Amortization of bond discount }=\frac{\text{Total bond}\text{discount }}{\text{Number of discount}}\\ =\frac{\$20,647,275}{30}\\ =\$688,243\end{array}$

Hence, amortization of discount on bond amount is $688,243.

Calculation of the amount of interest as on December 31, 2023 as shown below:

$\begin{array}{c}\text{Interest payable}\left(\text{Cash}\text{paid}\right)=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$150,000,000\times 10\%\times \frac{6}{12}\\ =\$7,500,000\end{array}$

Calculation of the interest expense on the bond as on December 31, 2025 as shown below:

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Interest payable}\text{+}\text{Discount}onBondsPayable\\ =\$7,500,000+\$688,243\\ =\$8,188,243\end{array}$

Hence, interest expense amount is $8,188,243.

• Interest Expense is an expense and it decreases the value of equity. Therefore, debit interest expense account by $8,188,243.
• Discount on bonds payable is a contra liability and it increases by $688,243. Therefore, credit discount on bonds payable account by $688,243.
• Cash is an asset and it decreases by $7,500,000. Therefore, credit cash account by $7,500,000.