Chapter 14, Problem 9APSA

To determine

1)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. These payments may be annual or semi-annual in nature and represent steady income and positive cash flows for investors

• Bonds are issued at par, at premium or at a discount. Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

To Determine:

Interest Expense to be recognized over bond’s life

Answer to Problem 9APSA

Solution:

Interest Expense to be recognized over bond’s life is $75,917

Explanation of Solution

Particulars	Amount ($)
Par Value	$250,000.00
Rate of Interest	6.50%
Duration of Bonds	5
Frequency of interest Payments	Semi - Annual
Interest Payable	$81,250.00
Premium on Issue received	$5,333.00
Net Interest Expense to be recognized	$75,917.00

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• The company issued 5 years 6.5% Bonds Payable with Par value of $250,000. Interest payable over a period of 5 years is calculated as product of Par Value, Rate of Interest and Duration of Bonds. Interest expense payable on Bonds is $81,250.

• Since the company has issued bonds at premium owing to the higher rate of interest of 6.5% as opposed to the market rate of 6%, premium on issue of bonds of $5,333 was received.

• This premium is to be amortized over the lifetime of the bonds against the interest expense payable and the net interest expense payable is calculated as the difference of Interest payable of $81,250 and premium on issue of $5,333 and is $75,917

Conclusion

Hence interest payable on bonds has been calculated.

To determine

2)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. These payments may be annual or semi-annual in nature and represent steady income and positive cash flows for investors.

• Interest expense paid has to be amortized by the company over the lifetime of the bonds. Any premium received on issue is reduced from the interest expense and the net expense is amortized over the lifetime of the bonds.

• Bonds are issued at par, at premium or at a discount. Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

To Prepare:

Interest Amortization Table

Answer to Problem 9APSA

Solution:

Bond Discount Amortization
Period	Date	Interest Paid Semi -Annually @ 13%	Market Rate of Interest Paid Semi - Annually @ 10%	Amortization Of Premium	Unamortized Premium	Net Book Value (For Effective Interest Calculation)
		[A]	[B]	[ A-B ]	[E]	[F] = [ $250,000 + E]
		(6.5% x 1/2 x 250,000)	(F x 6% x 1/2)
-	01-01-17				5,333	255,333
1	30-06-17	8,125	7,660	465	4,868	254,868
2	31-12-17	8,125	7,646	479	4,389	254,389
3	30-06-18	8,125	7,632	493	3,896	253,896
4	31-12-18	8,125	7,617	508	3,388	253,388
5	30-06-19	8,125	7,602	523	2,864	252,864
6	31-12-19	8,125	7,586	539	2,325	252,325
7	30-06-20	8,125	7,570	555	1,770	251,770
8	31-12-20	8,125	7,553	572	1,198	251,198
9	30-06-21	8,125	7,536	589	609	250,609
10	31-12-21	8,125	7,518	609	0	250,000

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• The method of amortization of interest is effective-interest amortization method. In this method, the effective rate of interest is the market rate of interest on the date of issue of the bonds.

• The company has issued bonds at premium, owing to the higher rate of interest of 6.5% as opposed to the market rate of 6%. Since the interest payments are semi-annual, the interest is calculated accordingly.

• The amount on which effective interest is calculated is the actual amount received from issue of bonds i.e. Par value plus Premium on Issue of Bonds for the first period and the net book value after premium amortized for the subsequent periods.

• The difference between the effective interest and actual interest paid is the amount of premium amortized during the period.

• During the last period the balance of unamortized premium is zero and the net interest expense payable over the lifetime of the bonds is reduced the premium received on issue.

Conclusion

Hence the interest amortization table is prepared.

To determine

3)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. They are issued at par, at premium or at a discount.

• Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

Journal Entries

• Journal entries are the first step in recording financial transactions and preparation of financial statements.

• These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.

• Assets and expenses have debit balances and Liabilities and Incomes have credit balances and according to the business transaction, the accounts are appropriately debited will be credited by credited to reflect the effect of business transactions and events.

To Prepare:

Journal entry to record first two interest payments on bonds

Answer to Problem 9APSA

Solution:

Date	Particulars	Debit ($)	Credit ($)
06.30.18	Interest Expense	$7,660
	Premium on Issue of Bonds	$465
	Cash		$8,125
	(Being interest paid and premium on issue of bonds amortized)
12.31.18	Interest Expense	$7,646
	Premium on Issue of Bonds	$479
	Cash		$8,125
	(Being interest paid and premium on issue of bonds amortized)

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par. If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• The method of amortization of interest is effective-interest amortization method. In this method, the effective rate of interest is the market rate of interest on the date of issue of the bonds.

• Market rate of interest is 6% and Interest paid on bonds is 6.5%. Since the interest payments are semi-annual, the interest is calculated accordingly.

• The amount on which effective interest is calculated is the actual amount received from issue of bonds i.e. Par value plus Premium on Issue of Bonds for the first period and the net book value after premium amortized for the subsequent periods.

• The difference between the effective interest and actual interest paid is the amount of premium amortized during the period

• Bonds Payable is a liability and therefore has a credit balance. In order to create the liability, they are credited. Cash is an asset and hence must be debited to indicate increase in balance.

• The difference between the face value of bonds payable and issue proceeds is the premium on issue of bonds. Since the premium on issue is amortized as per the effective interest method, the same is amortized with every interest payment.

Conclusion

Hence the transactions for the first two interest payments have been journalized.

To determine

4)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. They are issued at par, at premium or at a discount.

• Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

Net Present Value

• Net present value is the discounted value of the incremental future cash inflows of a bond in the form of interest payments, over its lifetime. It is calculated as sum of present value of principal and sum of present value of interest payable on bonds.

• A discounting factor is used to compute the present value of net incremental cash flows and usually the Market Rate of Return is used as the discounting factor to arrive at the net present value.

• Market Rate of Return is the minimum desired rate of return which a investment should pay as profit or gains in order to attract investor interest.

$\begin{array}{l}\text{Present value of Bond = Present Value of Principal at the time of maturity of bond + Present Value of}\\ \text{Interest over lifetime of the bond}\end{array}$

To Determine:

Present value of Bond as on 31 December 2019

Answer to Problem 9APSA

Solution:

Present value of Bond as on 31 December 2019 is $252,326

Explanation of Solution

Present value of Principal at the time of maturity of bond:

$\begin{array}{l}\text{PV(Principal)=Amount payable at redemption x Discounting factor(6\% market rate assumed as}\\ \text{discounting factor)}\\ \text{PV(Principal)=\$250,000 x 1/(1}{\text{.03)}}^{\text{4}}\\ \text{PV(Principal)=\$222,125}\end{array}$

Present Value of Interest over lifetime of the bond

$\begin{array}{l}\text{PV(Interest) = Interest on Bond x Annuity factor for semi-annual payments for 2 years)}\\ \text{PV(Interest) = \$250000 x 6}\text{.5\% x 6/12 x [(1/1}\text{.03})+\text{(1/1}{\text{.03}}^2)+\text{(1/1}{\text{.03}}^3)\text{+ (1/1}{\text{.03}}^{\text{4}})]\\ \text{[2 years of semi-annual payments means 4 periods]}\end{array}$

$\text{PV }\left(\text{Interest}\right)\text{ =\$ 30,201}$

$\begin{array}{l}\begin{array}{l}\begin{array}{l}\text{Present value of Bond = Present Value of Principal at the time of maturity of bond +}\\ \text{Present Value of Interest over lifetime of the bond}\end{array}\hfill \end{array}\begin{array}{l}\hfill \end{array}\\ \text{Present value of Bond = \$ 222,125 + \$ 30,201 =\$ 252,326}\end{array}$

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• Present value of bonds is calculated as the sum of the present value of the principal on maturity of the bonds and present value of sum of interest payments over the remainder of the lifetime of bonds.

• Present value of the principal of the bonds is calculated as the product of the face value of bonds and the annuity discounting factor at the end of the fourth period. Since there are 2 years remaining for the maturity of the bonds and interest is payable semi-annually, the discounting factor is taken accordingly.

• Present value of the interest of the bonds is calculated as the sum of present value of interest over the lifetime of the bonds by taking the product of the face value of bonds, rate of interest payable and the annuity discounting factor at the end of each period.Since there are 2 years remaining for the maturity of the bonds and interest is payable semi-annually, the discounting factor is taken accordingly.

Conclusion

Hence the Present value of the bonds is calculated.