Chapter 14, Problem 5APSA

To determine

Issue of bond at discount:

When the coupon rate or contract rate of a bond is lower than the market interest rate, the bond is being issued at discount. The selling price of the bond will be lower than the face value of the bond under issue of bond at discount.

Straight Line Method Amortization of discount:

Under straight line amortization method, a specific amount of discount is amortized each period till its maturity period. The period ending amortization amount is computed by dividing the total discount by the number of periods in maturity of the bonds payable.

To determine:

1. Preparation of journal entry to record the bond’s issuance.

2. Compute the total bond interest expense to be recognized over the life of the bonds.

3. Prepare the first two years of an amortization table using straight-line method.

4. Prepare the journal entries to record the first two interest payments.

5. Describe how the amounts reported on Legacy’s financial statement will be affected if the market rate on January 1, 2015, is 4% instead of 8%.

Answer to Problem 5APSA

Solution:

1.

Date	Accounts	Debit	Credit
2015
Jan. 1	Cash	$292,181
	Discount on Bonds Payable	$32,819
	Bonds Payable		$325,000

2. The total bond interest expense to be recognized over the bond’s life is $97,819.

3.

Period Ending	Unamortized Discount	Carrying Value
01/1/2015	$32,819	$292,181
06/30/2015	$28,717	$296,283
12/31/2015	$24,615	$300,385
06/30/2016	$20,513	$304,487
12/31/2016	$16,411	$308,589

4.

Date	General Journal	Debit	Credit
2015
Jun. 30	Interest Expense	$12,225
	Cash		$8,125
	Discount on Bonds Payable		$4,102
Dec. 31	Interest Expense	$12,225
	Cash		$8,125
	Discount on Bonds Payable		$4,102

5.

If the bonds were issued at market rate of 4% instead of 8%, the issue of bonds payable is on premium which will amortized every semiannual period over the life of the bonds. On the financial statement of the Legacy, the interest expense will be lesser and the interest payment in cash will greater. On the balance sheet, carrying value of the bonds payable will be more since the premium on bonds payable is added.

Explanation of Solution

Explanation:

1.

Computation of discount on bonds
Par Value of bonds payable	$325,000
Issue price of bonds payable	$292,181
Discount on bonds payable	$32,819

2.

Computation of total interest expense
Amount to be repaid at maturity:
Total Interest Payment	$65,000
Par Value of Bonds	$325,000
Total amount to be repaid	$390,000
Less : Selling Price of the Bonds	$292,181
Total Bond Interest Expense	$97,819

  $\begin{array}{l}*InterestPayment=\$8,125X\text{ 8 }=\$65,000\hfill \\ *SemiannualInterestPayment=\$325,000X0.025=\$8,125\hfill \end{array}$

3.
  $\begin{array}{l}\begin{array}{l}Discountamortizationpersemiannualperiod=\frac{Discountonbondspayable}{Numberofperiodinbonds’life}\\ =\frac{\$32,819}{8periods}\end{array}\hfill \\ =\$4,102perperiod\hfill \end{array}$

4.
  $\begin{array}{l}InterestPayment=ParValueofBondsPayableXCouponratepersemiannualperiod\hfill \\ =\$325,000X0.025\hfill \\ =\$8,125\hfill \\ \hfill \\ InterestExpense=InterestPayment+Discountamortizationperperiod\hfill \\ = \$8,125+\$4,102\hfill \\ =\$12,227\hfill \end{array}$

5. If the coupon rate of the bonds payable is more than the market rate, the issue is considered to be on premium.

Conclusion

Conclusion:

The total interest expense over the bond’s life of Legacy is $97,819 and every semiannual period a discount of $4,102 is amortized.