Concept Introduction:
Present value Present value, also known as discounted value is the current value for a future sum of money with a denied
The expected
Requirement a:
To calculate:
Proceeds of Learned Inc.'s bonds on January 1, 2016
Answer to Problem 7.32P
Proceeds from Learned Inc.'s bonds as on January 1, 2016= $61,650,540
Explanation of Solution
For calculation of proceeds (issue price) of the bonds on the issue date, firstly the interest payments made semi- annually would be calculated using the following formula:
In the given problem, it is given that the bonds have a face value of $70,000,000, interest rate of 14% and the time period is half year since the interest payments are made semi- annually.
The bonds have been issued on January 1, 2016 and will mature on December 31, 2035; it means they are 20 year bonds. Interest payments are made semi- annually which means twice a year. Thus, the interest will be paid over 40 years.
The stated market rate of interest at the time of issue of bonds was 16%. Therefore, the semi- annual interest rate can be calculated by multiplying the stated rate by half:
By using the present value table and taking values for 8% in 40 years, the factor is coming out to be 11.9246. Present value of interest payments can be calculated as follows:
Now, present value of maturity value needs to be calculated. For that by taking value of 8% in 40th period row, the factor is coming out to 0.0460. Thus, present value of maturity value would be:
Finally for calculating the proceeds of the bond, the present value of maturity value as well as of interest payments would be added and can be seen as follows:
Thus, proceeds from Learned Inc.'s bonds on January 1, 2016 are $61,650,540.
Concept Introduction:
Horizontal model A horizontal model is an arrangement of set of financial statements that encompasses the
Requirement b:
Horizontal model to show effects of semi- annual interest payment and related premium amortization
Answer to Problem 7.32P
Horizontal model showing effects of semi- annual interest payment and related premium amortization in the books of Learned Inc.
| Transaction | Balance sheet | Income statement |
| Assets= Liabilities+ | Net income= Revenue- Expenses | |
| Cash -$49,00,000
Premium on bonds payable -$60,000 | Interest expense -$48,40,000 |
Explanation of Solution
To record the effects of semi- annual interest payment and related premium amortization, firstly premium on bonds payable would be calculated. Premium on bonds payable is given as $24, 00,000 which is to be amortized on straight- line basis. This premium is given for 40 year periods, therefore premium amount for 1 year period would be:
For showing the effects of semi- annual interest payment and related premium amortization using horizontal model, following would be the adjustments required:
Horizontal model showing effects of semi- annual interest payment and related premium amortization in the books of Learned Inc.
| Transaction | Balance sheet | Income statement |
| Assets= Liabilities+ Stockholder equity | Net income= Revenue- Expenses | |
| Cash -$49,00,000
Premium on bonds payable -$60,000 | Interest expense -$48,40,000 |
Concept Introduction:
Straight- line amortization results in equal interest payment each year. Compound interest amortization results in higher interest expense during the early years of life of bond and decreases over time.
Requirement c:
Effect on interest expense if premium is amortized using compound interest method
Answer to Problem 7.32P
If the premium calculated in part (b) is amortized using the compound interest method, interest expense for the year ended December 31, 2016 would be more than the interest expense calculated using the straight- line method.
Explanation of Solution
If the premium calculated in part (b) is amortized using the compound interest method, interest expense for the year ended December 31, 2016 would be more than the interest expense calculated using the straight- line method.
Straight- line amortization results in equal interest payment each year. Compound interest amortization results in higher interest expense during the early years of life of bond and decreases over time.
Since the bond was issued on January 1, 2016, it can be assumed that compound interest amortization will be higher than straight- line amortization on December 31, 2016.
Concept Introduction:
Stated interest rate is the rate printed on the face
Requirement d:
Causes of difference between stated and market rate
Answer to Problem 7.32P
The difference exists because there is a short delay between time when bond issuer determines the stated interest rate of bonds and when bonds are actually sold.
Explanation of Solution
Normally, there is a small difference between the stated interest rate of bonds and the market interest rate at the time when bonds are issued.
The difference exists because there is a short delay between time bond issuer determines the stated interest rate of bonds and when bonds are actually sold.
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Chapter 7 Solutions
Principles of Financial Accounting (Elon University)
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