Chapter 7, Problem 36P

a.

To determine

Identify whether the market rate of interest was more or less than the stated interest rate, when the bonds were issued. Determine the amount received by the Company K, if the bond is sold at face value.

Explanation of Solution

Straight-line amortization bond: Straight line method of amortization is a process of amortizing premium on bond or discount on bond, which allocates the same amount of interest expense in each period of interest payment.

When the bonds were issued, the market rate of interest was more than the stated rate of interest. This is because; the bonds are sold at discount.

When the bonds had sold at face value, Company K would have received $200,000.

b.

To determine

Prepare the liabilities section of the balance sheet at December 31, 2018 and 2019.

Explanation of Solution

Prepare the liabilities section of the balance sheet at December 31, 2018 and 2019.

Company K
Balance sheet (Partial)
For the Year Ended December 31, 2018 and 2019
Particulars	2018	2019
Liabilities:
Interest Payable	4,000	4,000
Bonds Payable	200,000	200,000
Less: Discount on Bonds Payable	(5,375)	(4,625)
Carrying Value of Bonds Payable	194,625	195,375

(Table 9)

Working Notes:

Calculate the amount of discount on bonds payable for 2018.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable}\\ \text{ in 2018}\end{array}\}\text{ =}\left(\begin{array}{l}\text{Total Discount }\\ \text{on bond}\end{array}\right)-\left(\begin{array}{l}\text{Discount amortized}\\ \text{in}\text{2018}\end{array}\right)\\ =\$6,000-\left(\frac{\$6,000}{8}\times \frac{10}{12}\right)\\ =\$6,000-\$625\\ =\$5,375\end{array}$

Calculate the amount of discount on bonds payable for 2019.

$\begin{array}{c}\begin{array}{l}\text{Discount on bond payable}\\ \text{in 2019}\end{array}\}\text{ =}\left(\begin{array}{l}\text{Discount on bond}\\ \text{ payable in 2018}\end{array}\right)-\left(\begin{array}{l}\text{Discount amorized }\\ \text{in 2019}\end{array}\right)\\ =\$5,375-\left(\frac{\$6,000}{8}\right)\\ =\$5,375-\$750\\ =\$4,625\end{array}$

c.

To determine

Calculate the amount of interest expense that Company K would report on the income statements for the 2018 and 2019.

Explanation of Solution

Calculate the amount of interest expense that Company K would report on the income statements for the 2018.

$\begin{array}{c}\text{Interest expense for 2018 = }\left(\begin{array}{l}\text{Interest for 10 months }\\ \text{+ Amortization of discount for 10 months}\end{array}\right)\\ =\left(\$200,000\times 6\%\times \frac{10}{12}\right)\text{}+\left(\frac{\$6,000}{8}\times \frac{10}{12}\right)\\ =\$10,000+\$625\\ =\$10,625\end{array}$

Hence, the amount of interest expense that Company K would report on the income statements for 2018 is $10,625.

Calculate the amount of interest expense that Company K would report on the income statements for the 2019.

$\begin{array}{c}\text{Interest expense for 2019 = }\left(\begin{array}{l}\text{Interest for 12 months }\\ \text{+ Amortization of discount for 12 months}\end{array}\right)\\ =\left(\$200,000\times 6\%\right)\text{}+\left(\frac{\$6,000}{8}\right)\\ =\$12,000+\$750\\ =\$12,750\end{array}$

Hence, the amount of interest expense that Company K would report on the income statements for 2019 is $12,750.

d.

To determine

Calculate the amount of interest expense that Company K would pay to the bondholders in 2018 and 2019.

Explanation of Solution

Calculate the amount of interest expense that Company K would pay to the bondholders in 2018.

$\begin{array}{c}\text{Cash interest paid = Face value of bonds}\times \text{ Stated interest rate}\times \text{Time period}\\ \text{=}\left(\$200,000\times 6\%\times \frac{6}{12}\right)\\ =\$6,000\end{array}$

Hence, the amount of interest expense that Company K would pay to the bondholders in 2018 is $6,000.

Calculate the amount of interest expense that Company K would pay to the bondholders in 2019.

$\begin{array}{c}\text{Cash interest paid = Face value of bonds}\times \text{ Stated interest rate}\times \text{Time period}\\ \text{=}\left(\$200,000\times 6\%\times \frac{12}{12}\right)\\ =\$12,000\end{array}$

Hence, the amount of interest expense that Company K would pay to the bondholders in 2019 is $12,000.