Chapter 22, Problem 1MP

MASTERY PROBLEM

Jackson, Inc.’s fiscal year ends December 31. Selected transactions for the period 20-1 through 20-8 involving bonds payable issued by Jackson are as follows:

20-1

Oct. 31 Issued $600,000 of 10-year, 7%, callable bonds dated October 31, 20-1, for $612,000. Interest is payable semiannually on October 31 and April 30. The bond indenture provides that Jackson is to pay to the trustee bank $20,000 by May 15 of each year (except the tenth year) as a sinking fund for the retirement of the bonds on call or at maturity.

Dec. 31 Made the adjusting entry for interest payable and amortized two months’ premium on the bonds (straight-line method).

20-2

Jan. 2 Reversed the adjusting entry for interest payable and bond premium amortization.

Apr. 30 Paid the semiannual interest on the bonds and amortized six months’ premium.

May 15 Paid the sinking fund trustee $20,000.

Oct. 31 Paid the semiannual interest on the bonds and amortized six months’ premium.

Dec. 31 Made the adjusting entry for interest payable and amortized two months’ premium on the bonds.

31 Sinking fund earnings for the year were $900.

20-8

May 15 Paid the sinking fund trustee $20,000.

Oct. 31 Paid the semiannual interest on the bonds and amortized six months’ premium.

31 Redeemed the bonds, which were called at 97.

The balance in the bond premium account is $3,600 after the payment of interest and amortization of premium have been entered. The cash balance in the sinking fund is $200,000, which is applied to the redemption. Jackson paid the sinking fund trustee the additional cash needed to pay off the bonds. (Hint: First make the entry for payment to the sinking fund, then make the entry for redemption of the bonds.)

REQUIRED

1. Enter the preceding transactions in general journal form.

2. Calculate the carrying value of the bonds as of December 31, 20-2.

To determine

Journalize the bond transactions for Incorporation J.

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 bond transactions for Incorporation J.

Transaction on October 31, 20-1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-1
October	31	Cash			612,000
			Bonds Payable			600,000
			Premium on Bonds Payable			12,000
		(Record issuance of bonds at premium)

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.
• Bonds Payable is a liability account. Since the liability to pay bonds has increased, liability increased, and an increase in liability is credited.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Therefore, the respective liability account is increased, and an increase in liability is credited.

Working Notes:

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

$\begin{array}{c}\text{Premium on bonds payable = }\left\{\begin{array}{l}\text{Cash received – }\\ \text{Face value of bonds}\end{array}\right\}\\ \text{=\$612,000–\$600,000}\\ \text{=\$12,000}\end{array}$ (1)

Transaction on December 31, 20-1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-1
December	31	Bond Interest Expense			6,800
		Premium on Bonds Payable			200
			Bond Interest Payable			7,000
		(Record interest expense accrued)

Table (2)

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.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the premium is amortized, the premium value is reduced, and a decrease in liability is debited.
• 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.

$\begin{array}{c}\text{Accrued bond interest payable = }\left\{\begin{array}{l}\text{Face value of the bonds×}\\ \text{Stated interest rate×}\\ \text{Period of the interest accrued}\\ \left(\text{October 31 to December 31}\right)\end{array}\right\}\\ \text{=\$600,000×7\%×}\frac{2}{\text{12}}\\ \text{=\$7,000}\end{array}$ (2)

Compute the amount of amortized premium.

$\begin{array}{c}\text{Premium amortized = }\left\{\begin{array}{l}\frac{\text{Unamortized premium}}{\text{Life of the bonds}}\text{×}\\ \text{Accrued interest period}\end{array}\right\}\\ \text{=}\frac{\text{\$12,000}}{\text{10 years}}\text{×}\frac{2}{\text{12}}\\ \text{=\$200}\end{array}$ (3)

Note: Refer to Equation (1) for value and computation of unamortized premium.

Compute the amount of bond interest expense.

$\begin{array}{c}\text{Bond interest expense = Bond interest payable–Premium amortized}\\ \text{=\$7,000–\$200}\\ \text{=\$6,800}\end{array}$ (4)

Note: Refer to Equations (2) and (3) for both the values.

Transaction on January 2, 20-2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
January	2	Bond Interest Payable			7,000
			Bond Interest Expense			6,800
			Premium on Bonds Payable			200
		(Record reversing entry for the accrued interest expense)

Table (3)

Description:

• Bond Interest Payable is a liability account. Since the entry is reversed, 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.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the entry is reversed, the liability which was debited earlier is credited now.

Note: Refer to Equations (2), (3), and (4) for the computation of all the values.

Transaction on April 30, 20-2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
April	30	Bond Interest Expense			20,400
		Premium on Bonds Payable			600
			Cash			21,000
		(Record payment of semiannual interest and the amortization of premium)

Table (4)

Description:

• Bond Interest Expense is an expense account. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the premium is amortized, the premium value is reduced, and a decrease in liability is debited.
• 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.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\text{Face value of the bonds×}\\ \text{Stated interest rate×}\\ \text{Semiannual interest payment period}\end{array}\right\}\\ \text{=\$600,000×7\%×}\frac{\text{1}}{\text{2}}\\ \text{=\$21,000}\end{array}$ (5)

Compute the amount of amortized premium.

$\begin{array}{c}\text{Premium amortized = }\left\{\begin{array}{l}\frac{\text{Unamortized premium}}{\text{Life of the bonds}}\text{×}\\ \text{Semiannual interest payment period}\end{array}\right\}\\ \text{=}\frac{\text{\$12,000}}{\text{10 years}}\text{×}\frac{\text{1}}{\text{2}}\\ \text{=\$600}\end{array}$ (6)

Note: Refer to Equation (1) for value and computation of unamortized premium.

Compute the amount of bond interest expense.

$\begin{array}{c}\text{Bond interest expense = Cash paid–Premium amortized}\\ \text{=\$21,000–\$600}\\ \text{=\$20,400}\end{array}$ (7)

Note: Refer to Equations (5) and (6) for both the values.

Transaction on May 15, 20-2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
May	15	Bond Sinking Fund			20,000
			Cash			20,000
		(Record the deposit to the bond sinking fund)

Table (5)

Description:

• Bond Sinking Fund is an asset account. Since the cash is contributed to the fund, the asset value decreased, and an increase in asset is debited.
• Cash is an asset account. The amount is decreased because cash is paid, and a decrease in assets should be credited.

Transaction on October 31, 20-2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
October	31	Bond Interest Expense			20,400
		Premium on Bonds Payable			600
			Cash			21,000
		(Record payment of semiannual interest and the amortization of premium)

Table (6)

Description:

• Bond Interest Expense is an expense account. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the premium is amortized, the premium value is reduced, and a decrease in liability is debited.
• 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 (5), (6), and (7) for all the values.

Transaction on December 31, 20-2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
December	31	Bond Interest Expense			6,800
		Premium on Bonds Payable			200
			Bond Interest Payable			7,000
		(Record interest expense accrued)

Table (7)

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.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the premium is amortized, the premium value is reduced, and a decrease in liability is debited.
• Bond Interest Payable is a liability account. Since the liability to pay interest has increased, liability increased, and an increase in liability is credited.

Note: Refer to Equations (2), (3), and (4) for all the values.

Transaction on December 31, 20-2:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-2
December	31	Bond Sinking Fund			900
			Sinking Fund Earnings			900
		(Record the earnings received from sinking fund)

Table (8)

Description:

• Bond Sinking Fund is an asset account. Since the cash is contributed to the fund, the asset value decreased, and an increase in asset is debited.
• Sinking Fund Earnings is a revenue account. Revenues increase the stockholders’ equity, and an increase in equity is credited.

Transaction on May 15, 20-8:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-8
May	15	Bond Sinking Fund			20,000
			Cash			20,000
		(Record the deposit to the bond sinking fund)

Table (9)

Description:

• Bond Sinking Fund is an asset account. Since the cash is contributed to the fund, the asset value decreased, and an increase in asset is debited.
• Cash is an asset account. The amount is decreased because cash is paid, and a decrease in assets should be credited.

Transaction on October 31, 20-8:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-8
October	31	Bond Interest Expense			20,400
		Premium on Bonds Payable			600
			Cash			21,000
		(Record payment of semiannual interest and the amortization of premium)

Table (10)

Description:

• Bond Interest Expense is an expense account. Expenses reduce the stockholders’ equity account, and a decrease in equity is debited.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the premium is amortized, the premium value is reduced, and a decrease in liability is debited.
• 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 (5), (6), and (7) for all the values.

Transaction on October 31, 20-8:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-8
October	31	Bond Sinking Fund			382,000
			Cash			382,000
		(Record the redemption of bonds)

Table (11)

Description:

• Bond Sinking Fund is an asset account. Since the cash is contributed to the fund, the asset value decreased, and an increase in asset is debited.
• 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 amount of cash paid by J to the fund.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Face value of bonds × }\\ \text{Bond price quotation percentage}\end{array}\right)\text{–}\\ \text{Cash balance in the sinking fund}\end{array}\right\}\\ \text{=}\left(\text{\$600,000×97\%}\right)–\$200,000\\ \text{=\$382,000}\end{array}$

Transaction on October 31, 20-8:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
20-8
October	31	Bonds Payable			600,000
		Premium on Bonds Payable			3,600
			Gain on Bonds Redeemed			21,600
			Bond Sinking Fund			582,000
		(Record the redemption of bonds)

Table (12)

Description:

• Bonds Payable is a liability account. Since the liability to pay bonds has decreased, liability decreased, and a decrease in liability is debited.
• Premium on Bonds Payable account is an adjunct-liability account, the account which increases the balance of the respective liability account. Since the premium is amortized, the premium value is reduced, and a decrease in liability is debited.
• Gain on Bonds Redeemed is a revenue account. Revenues increase the stockholders’ equity, and an increase in equity is credited.
• Bond Sinking Fund is an asset account. The amount is decreased because the cash in the fund is distributed to redeem the bonds, and a decrease in assets should be credited.

Working Notes:

Compute the carrying value of the bonds redeemed.

$\begin{array}{c}\text{Carrying value = Face value of bonds+Unamortized premium}\\ \text{=\$600,000+\$3,600}\\ \text{=\$603,600}\end{array}$ (8)

Compute cash paid or redemption price (from sinking fund).

$\begin{array}{c}\text{Cash paid = Face value of bond×Bond price quotation}\\ \text{=\$600,000×97\%}\\ \text{=\$582,000}\end{array}$ (9)

Compute gain (loss) on redemption of bonds.

$\begin{array}{c}\text{Gain }\left(\text{loss}\right)\text{ = Carrying value of bonds – Cash paid}\\ \text{=\$603,600–\$582,000}\\ \text{=\$21,600}\end{array}$

Note: Refer to Equations (8) and (9) for the value and computation of both the values.

To determine

Compute the carrying value of bonds on December 31, 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 premium amortization schedule to compute the amount of carrying value of the bonds on December 31, 20-2.

Date	Interest Expense Debit (1)	Premium on Bonds Payable Debit (2)	Cash Credit (3)	Bonds Payable Balance (4)	Premium on Bonds Payable (5)	Carrying Value of Bonds (6)
			$\begin{array}{c}\left[\left(1\right)+\left(2\right)\right]\end{array}$		$\begin{array}{c}\left[\left(5\right)–\left(2\right)\right]\end{array}$	$\begin{array}{c}\left[\left(4\right)+\left(5\right)\right]\end{array}$
10/31/-1				$600,000	$12,000	$612,000
04/30/-2	$20,400	$600	$21,000	600,000	11,400	611,400
10/31/-2	20,400	600	21,000	600,000	10,800	610,800
12/31/-2	6,800	200	7,000	600,000	10,600	$610,600

Table (13)

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

Conclusion

Thus, the amount of carrying value of the bonds on December 31, 20-2 is $610,600.