Chapter 14, Problem 14.8P

Bonds; effective interest; partial period interest; financial statement effects

• LO14–2

The fiscal year ends December 31 for Lake Hamilton Development. To provide funding for its Moonlight Bay project, LHD issued 5% bonds with a face amount of $500,000 on November 1, 2018. The bonds sold for $442,215, a price to yield the market rate of 6%. The bonds mature October 31, 2038 (20 years). Interest is paid semiannually on April 30 and October 31.

Required:

1. 1. What amount of interest expense related to the bonds will LHD report in its income statement for the year ending December 31, 2018?
2. 2. What amount(s) related to the bonds will LHD report in its balance sheet at December 31, 2018?
3. 3. What amount of interest expense related to the bonds will LHD report in its income statement for the year ending December 31, 2019?
4. 4. What amount(s) related to the bonds will LHD report in its balance sheet at December 31, 2019?

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.

To Calculate: The amount that L would report in its income statement for the year ending December 31, 2018.

Explanation of Solution

L would report the amount of interest expense to its income statement. The total amount of interest expense for 2016 is calculated as below:

$\begin{array}{c}\text{Interest expense for 2018 = }\left(\begin{array}{l}\text{Price of bonds}\times \text{Market interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$442,215\times 6\%\times \frac{2}{12}\\ =\$4,422\end{array}$

Therefore, interest expense amount for 2018 is $4,422.

To determine

To Calculate:  The amount related to bonds that L would report in its balance sheet at December 31, 2018.

Explanation of Solution

Calculate the liability amount would be reported in the balance sheet as on 31^st December 2018.

Particulars	Amount
Bonds payable	$500,000
Less: Discount on bonds payable(1)	$57,785
Initial balance of bonds (price of bonds), November 1, 2018	$442,215
Less: Discount amortization on December 31, 2018(4)	$255
Net bonds payable on December 31, 2018	$442,470
Interest payable(2)	$4,167

Table (1)

Working notes:

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable }=\text{Bonds payable –}\text{Price of bonds}\\ =\$5,000,000-\$442,215\\ =\$57,785\end{array}$

Hence, discount on bonds payable amount is $57,785.

(1)

Calculate the amount of interest as on December 31, 2018.

$\begin{array}{c}\text{Interest payable}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 5\%\times \frac{2}{12}\\ =\$4,167\end{array}$

Hence, interest payable amount $4,167.

(2)

Calculate the interest expense on the bond as on December 31, 2018.

$\begin{array}{c}\text{Interest expense}=\text{Price of bonds}\times \text{Market interest rate}\times \text{Interest time period}\\ =\$442,215\times 6\%\times \frac{2}{12}\\ =\$4,422\end{array}$

Hence, interest expense amount is $4,422.

(3)

Calculate discount amortization on December 31, 2018.

$\begin{array}{c}\text{Discount amortization on December 31, 2018 }=\left(\begin{array}{l}\text{Interest expense }\\ \text{–}\text{Interest payable}\end{array}\right)\\ =\$4,422-\$4,167\\ =\$255\end{array}$

Hence, discount amortization amount is $255.

(4)

Therefore, L would report bonds payable of $442,470 and interest payable of $4,167in its balance sheet at December 31, 2018.

To determine

To Calculate: The amount that L would report in its income statement for the year ended December 31, 2019.

Explanation of Solution

L would report the amount of interest expense to its income statement. The total amount of interest expense for 2019 is calculated as below:

$\begin{array}{c}\text{Interest expense for 2019 = }\left(\begin{array}{l}\text{Interest expense on April 30, 2019 }\\ \text{+ Interest expense on October 31, 2019}\\ \text{+}\text{Interest expense on December 31, 2019}\end{array}\right)\\ =\$8,844+\$13,289+\$4,438\\ =\$26,571\end{array}$

Therefore, interest expense amount for 2019 is $26,571.

To determine

To Calculate: The amount related to bonds that L would report in its balance sheet at December 31, 2019.

Explanation of Solution

Calculate the liability amount would be reported in the balance sheet as on 31^st December 2019.

Particulars	Amount
Balance of bonds as on December 31, 2018	$442,470
Less: Discount amortization on April 30, 2019(7)	$(511)
Discount amortization on October 31, 2019(10)	$(789)
Discount amortization on December 31, 2019(12)	$(271)
Net bonds payable on December 31, 2019	$442,041
Interest payable	$4,167

Table (2)

Working notes:

Calculate the amount of interest as on April 30, 2019.

$\begin{array}{c}\text{Interest paid (cash paid)}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 5\%\times \frac{6}{12}\\ =\$12,500\end{array}$

Hence, Interest paid amount is $12,500.

(5)

Calculate the interest expense on the bond as on April 30, 2019.

$\begin{array}{c}\text{Interest expense}=\text{Price of bonds}\times \text{Market interest rate}\times \text{Interest time period}\\ =\$442,215\times 6\%\times \frac{4}{12}\\ =\$8,844\end{array}$

Hence, interest expense amount is $8,844.

(6)

Calculate discount amortization on April 30, 2019.

$\begin{array}{c}\text{Discount amortization on April 30, 2019 }=\left(\begin{array}{l}\text{Interest expense + Interest payable }\\ \text{–}\text{Cash paid}\end{array}\right)\\ =\$8,844+\$4,167-\$12,500\\ =\$511\end{array}$

Hence, discount amortization amount is $511.

(7)

Calculate the amount of interest as on October 31, 2019.

$\begin{array}{c}\text{Interest paid (cash paid)}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 5\%\times \frac{6}{12}\\ =\$12,500\end{array}$

Hence, interest paid amount is $12,500.

(8)

Calculate the interest expense on the bond as on October 31, 2019.

$\begin{array}{c}\text{Interest expense}=\left(\$442,215+\$255+\$511\right)\times 6\%\times \frac{6}{12}\\ =\$13,289\end{array}$

Hence, interest expense amount is $13,289.

(9)

Calculate discount amortization on October 31, 2019.

$\begin{array}{c}\text{Discount amortization on October 31, 2019 }=\left(\text{Interest expense –}\text{Cash paid}\right)\\ =\$13,289-\$12,500\\ =\$789\end{array}$

Hence, discount amortization amount is $789.

(10)

Calculate the amount of interest as on December 31, 2019.

$\begin{array}{c}\text{Interest payable}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$500,000\times 5\%\times \frac{2}{12}\\ =\$4,167\end{array}$

Hence, interest payable amount is $4,167.

(11)

Calculate the interest expense on the bond as on December 31, 2019.

$\begin{array}{c}\text{Interest expense}=\left(\$442,215+\$255+\$511+\$789\right)\times 6\%\times \frac{2}{12}\\ =\$4,438\end{array}$

Hence, interest expense amount is $4,438.

Calculate discount amortization on December 31, 2019.

$\begin{array}{c}\text{Discount amortization on December 31, 2019 }=\left(\begin{array}{l}\text{Interest expense }\\ \text{–}\text{Interest payable}\end{array}\right)\\ =\$4,438-\$4,167\\ =\$271\end{array}$

Hence, discount amortization amount is $271.

(12)

Therefore, L would report bonds payable of $442,041 and interest payable of $4,167in its balance sheet at December 31, 2019.