Issue of bond at premium:
When the coupon rate or contract rate of a bond is higher than the market interest rate, the bond is being issued at premium. If the bond is issued at premium, the selling price of the bond will be higher than the face value of the bond.
Effective interest method:
Effective interest method aims at computing an accurate interest expense. In case of issue of bonds on premium, the carrying value of the bonds payable inclusive of premium amortized is used to determine the interest expense during a particular period. Hence the interest expense decreases as the carrying value of the bonds decrease.
To determine:
1. Preparation of format of amortization table for bond premium using effective interest method.
2 Allocating the amounts in their respective columns
3. Determine the final number in each column.
4. Computation of total bond interest expense over the life of the bonds.
5. Prepare similarities and differences between the amortization table for premium and discount.
![Check Mark](/static/check-mark.png)
Answer to Problem 6BTN
Solution:
1.
Period Ending | Cash Interest Paid | Bond Interest Expense | Premium Amortization | Unamortized Premium | Carrying Value |
2.
Period Ending | (A) Cash Interest Paid 4.5% X Par Value | (B) Bond Interest Expense 4% X Prior (E) | (C) Premium Amortization (A) − (B) | (D) Unamortized Premium Prior (D) − (C) | (E) Carrying Value Par Value + (D) |
01/1/2015 | $4,100 | $104,100 | |||
06/30/2015 | $4,500 | $4,164 | $336 | $3,764 | $103,764 |
12/31/2015 | $4,500 | $4,151 | $349 | $3,415 | $103,415 |
06/30/2016 | $4,500 | $4,137 | $363 | $3,052 | $103,052 |
12/31/2016 | $4,500 | $4,122 | $378 | $2,674 | $102,674 |
06/30/2017 | $4,500 | $4,107 | $393 | $2,281 | $102,281 |
12/31/2017 | $4,500 | $4,091 | $409 | $1,872 | $101,872 |
06/30/2018 | $4,500 | $4,075 | $425 | $1,447 | $101,447 |
12/31/2018 | $4,500 | $4,058 | $442 | $1,005 | $101,005 |
06/30/2019 | $4,500 | $4,040 | $460 | $545 | $100,545 |
3. Final numbers of each column
12/31/2019 | $4,500 | $3,955 | $545 | 0 | $100,000 |
$45,000 | $40,900 | $4,100 |
4. The total interest expense over the life of the bonds is $40,900.
5.
Similarities | Issue of bonds on premium | Issue of bonds on discount |
Cash Interest Payment | Constant over the bonds’ life | Constant over the bonds’ life |
Unamortized Discount / Premium | Diminishing periodically till maturity | Diminishing periodically till maturity |
Differences | ||
Bond Interest Expense | Decreases periodically over the life of the bonds. | Increases periodically over the life of the bonds. |
Discount /Premium Amortization | Premium amortization per period is computed by deducting the interest expense from the cash interest payment. | Discount amortization per period is computed by deducting the cash interest payment from the interest expense. |
Carrying Value | The carrying value decreases periodically till it becomes equal to par value at the maturity. (Par Value + Unamortized Premium) | The carrying value increases periodically till it becomes equal to par value at the maturity. (Par Value - Unamortized Discount) |
Explanation of Solution
Explanation:
2.
Same steps are followed through all the period till the maturity of the bonds.
4.
Computation of total interest expense | |
Amount to be repaid at maturity: | |
Total Interest Payment | $45,000 |
Par Value of Bonds | $100,000 |
Total amount to be repaid | $145,000 |
Less : Selling Price of the Bonds | $104,100 |
Total Bond Interest Expense | $40,900 |
Conclusion:
Thus, from the above we can clearly understand the differences and the similarities between the amortization table for premium and discount.
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Chapter 14 Solutions
FUNDAMENTAL ACCT PRIN TEXT+CONNECT CODE
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