Chapter 22, Problem 10SPA

1-(a)

To determine

Journalize the entry for the issuance of bonds in the books of Incorporation E.

Explanation of Solution

Bonds: Bonds are the financial debt instruments issued by the corporations to raise capital for the purposes of purchasing assets, or paying debts. Bonds are bought by individual investors, or corporations, or mutual funds, and receive a fixed interest revenue.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Journalize the entry for the issuance of bonds in the books of Incorporation E.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-1
April	1	Cash			485,000
		Discount on Bonds Payable			15,000
			Bonds Payable			500,000
		(Record issuance of bonds at discount)

Table (1)

Description:

• Cash is an asset account. The amount is increased because cash is received from the bond issue, and an increase in assets should be debited.
• Discount on Bonds Payable account is a contra-liability account, the account which decreases the balance of the respective liability account. Therefore, the respective liability account is decreased, and a decrease in liability is debited.
• Bonds Payable is a liability account. Since the liability to pay bonds has increased, liability increased, and an increase in liability is credited.

Working Notes:

Compute the amount of cash received.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\text{Face value of bonds × }\\ \text{Bond price quotation percentage}\end{array}\right\}\\ \text{=\$500,000×97\%}\\ \text{=\$485,000}\end{array}$ (1)

Compute the amount of discount on bonds payable (unamortized discount).

$\begin{array}{c}\text{Discount on bonds payable = }\left\{\begin{array}{l}\text{Face value of bonds}–\\ \text{Cash received }\end{array}\right\}\\ \text{=\$500,000–\$485,000}\\ \text{=\$15,000}\end{array}$ (2)

Note: Refer to Equation (1) for value and computation of cash received.

(b)

To determine

Journalize the entry for the semiannual interest payment and discount amortization in the books of Incorporation E.

Explanation of Solution

Journalize the entry for the semiannual interest payment and discount amortization in the books of Incorporation E.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-1
September	30	Bond Interest Expense			20,375
			Discount on Bonds Payable			375
			Cash			20,000
		(Record payment of semiannual interest and the amortization of discount)

Table (2)

Description:

• Bond Interest Expense is an expense account. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Discount on Bonds Payable account is a contra-liability account, the account which decreases the balance of the respective liability account. Since the discount is amortized, the discount value is reduced, and a decrease in contra-liability is credited.
• Cash is an asset account. The amount is decreased because cash is paid, and a decrease in assets should be credited.

Working Notes:

Compute the cash paid.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\text{Face value of the bonds×}\\ \text{Stated interest rate×}\\ \text{Semiannual interest payment period}\end{array}\right\}\\ \text{=\$500,000×8\%×}\frac{\text{1}}{\text{2}}\\ \text{=\$20,000}\end{array}$ (3)

Compute the amount of amortized discount.

$\begin{array}{c}\text{Discount amortized = }\left\{\begin{array}{l}\frac{\text{Unamortized discount}}{\text{Life of the bonds}}\text{×}\\ \text{Semiannual interest payment period}\end{array}\right\}\\ \text{=}\frac{\text{\$15,000}}{\text{20 years}}\text{×}\frac{\text{1}}{\text{2}}\\ \text{=\$375}\end{array}$ (4)

Note: Refer to Equation (2) for value and computation of unamortized discount.

Compute the amount of bond interest expense.

$\begin{array}{c}\text{Bond interest expense = Cash paid+Discount amortized}\\ \text{=\$20,000+\$375}\\ \text{=\$20,375}\end{array}$ (5)

Note: Refer to Equation (3) and (4) for both the values.

(c)

To determine

Journalize the entry for the year-end adjustment in the books of Incorporation E.

Explanation of Solution

Journalize the entry for the year-end adjustment in the books of Incorporation E.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-1
December	31	Bond Interest Expense			10,187.50
			Discount on Bonds Payable			187.50
			Bond Interest Payable			10,000.00
		(Record interest expense accrued)

Table (3)

Description:

• Bond Interest Expense is an expense account. Since the interest is accrued, the interest expense increased. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Discount on Bonds Payable account is a contra-liability account, the account which decreases the balance of the respective liability account. Since the discount is amortized, the discount value is reduced, and a decrease in contra-liability is credited.
• Bond Interest Payable is a liability account. Since the liability to pay interest has increased, liability increased, and an increase in liability is credited.

Working Notes:

Compute the accrued bond interest payable amount.

$\begin{array}{c}\text{Accrued bond interest payable = }\left\{\begin{array}{l}\text{Face value of the bonds×}\\ \text{Stated interest rate×}\\ \text{Period of the interest accrued}\\ \left(\text{October 1 to December 31}\right)\end{array}\right\}\\ \text{=\$500,000×8\%×}\frac{3}{\text{12}}\\ \text{=\$10,000}\end{array}$ (6)

Compute the amount of amortized discount.

$\begin{array}{c}\text{Discount amortized = }\left\{\begin{array}{l}\frac{\text{Unamortized discount}}{\text{Life of the bonds}}\text{×}\\ \text{Accrued interest period}\end{array}\right\}\\ \text{=}\frac{\text{\$15,000}}{\text{20 years}}\text{×}\frac{3}{\text{12}}\\ \text{=\$187}\text{.50}\end{array}$ (7)

Note: Refer to Equation (2) for value and computation of unamortized discount.

Compute the amount of bond interest expense.

$\begin{array}{c}\text{Bond interest expense = Accrued bond interest payable+Discount amortized}\\ \text{=\$10,000+\$187}\text{.50}\\ \text{=\$10,187}\text{.50}\end{array}$ (8)

Note: Refer to Equation (6) and (7) for both the values.

(d)

To determine

Journalize the entry to reverse the year-end adjustment in the books of Incorporation E.

Explanation of Solution

Journalize the entry to reverse the year-end adjustment in the books of Incorporation E.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
January	1	Bond Interest Payable			10,000.00
		Discount on Bonds Payable			187.50
			Bond Interest Expense			10,187.50
		(Record reversing entry for the accrued interest expense)

Table (4)

Description:

• Bond Interest Payable is a liability account. Since the entry is reversed, liability which was credited earlier is debited now.
• Discount on Bonds Payable account is a contra-liability account, the account which decreases the balance of the respective liability account. Since the entry is reversed, the liability which was credited earlier is debited now.
• Bond Interest Expense is an expense account. Since the entry is reversed, the stockholders’ equity which was debited earlier is credited now.

Note: Refer to Equations (6), (7), and (8) for the computation of all values.

(e)

To determine

Journalize the entry for the semiannual interest payment and discount amortization for 20-2, in the books of Incorporation E.

Explanation of Solution

Journalize the entry for the semiannual interest payment and discount amortization in the books of Incorporation E, on September 30.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
September	30	Bond Interest Expense			20,375
			Discount on Bonds Payable			375
			Cash			20,000
		(Record payment of semiannual interest and the amortization of discount)

Table (5)

Description:

• Bond Interest Expense is an expense account. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Discount on Bonds Payable account is a contra-liability account, the account which decreases the balance of the respective liability account. Since the discount is amortized, the discount value is reduced, and a decrease in contra-liability is credited.
• Cash is an asset account. The amount is decreased because cash is paid, and a decrease in assets should be credited.

Note: Refer to Equations (3), (4), and (5) for both the values.

Journalize the entry for the semiannual interest payment and discount amortization in the books of Incorporation E, on March 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
March	31	Bond Interest Expense			20,375
			Discount on Bonds Payable			375
			Cash			20,000
		(Record payment of semiannual interest and the amortization of discount)

Table (6)

Description:

• Bond Interest Expense is an expense account. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Discount on Bonds Payable account is a contra-liability account, the account which decreases the balance of the respective liability account. Since the discount is amortized, the discount value is reduced, and a decrease in contra-liability is credited.
• Cash is an asset account. The amount is decreased because cash is paid, and a decrease in assets should be credited.

Note: Refer to Equations (3), (4), and (5) for both the values.

2.

To determine

Compute the amount of carrying value of the bonds on September 30, 20-2.

Explanation of Solution

Carrying value: The carrying value of a bond is the sum of face value and the unamortized premium or the difference between the face value and the amortized discount. This is the value that is recorded on the balance sheet and is also referred to as book value.

Prepare a bond discount amortization schedule to compute the amount of carrying value of the bonds on September 30, 20-2.

Date	Interest Expense Debit (1)	Discount on Bonds Payable Credit (2)	Cash Credit (3)	Bonds Payable Balance (4)	Discount on Bonds Payable (5)	Carrying Value of Bonds (6)
			$\begin{array}{c}\left[\left(1\right)–\left(2\right)\right]\end{array}$		$\begin{array}{c}\left[\left(5\right)–\left(2\right)\right]\end{array}$	$\begin{array}{c}\left[\left(4\right)–\left(5\right)\right]\end{array}$
4/01/-1				$500,000	$15,000	$485,000
9/30/-1	$20,375	$375	$20,000	500,000	14,625	485,375
3/31/-2	20,375	375	20,000	500,000	14,250	485,750
9/30/-2	20,375	375	20,000	500,000	13,875	$486,125

Table (7)

Note: Refer to Requirement (1) for the computation of all values.

Conclusion

Thus, the amount of carrying value of the bonds on September 30, 20-2 is $486,125.