Chapter 9, Problem 70E

To determine

(a)

Introduction:

A bond is long term liability wherein the issuer is entitled to pay the face value of the bond at the time of maturity and make interest payments periodically. It is a breakdown of large debt to borrow as it may be too large for an individual lender.

To record:

Journal entry for the issuance of bonds.

Answer to Problem 70E

Journal Entry for issuance of bonds on premium

Particulars	Debit ($)	Credit ($)
Cash Dr. Bonds Payable Premium on Bonds Payable	2,090,000	2,000,000 90,000

Explanation of Solution

Given:

Bonds with face value of $2,000,000 sold for $2,090,000 with 6% stated rate.

The face value of bonds issued is recorded as bonds payable and any premium or discount on issue of bonds is recorded in separate “Premium on Bonds Payable” or “Discount on Bonds Payable” account whereas in case of issuance of bonds at par it is a regular journal entry where cash (asset) increased along with Bonds Payable (long term liability).

Journal Entry for issuance of bonds on premium

Particulars	Debit ($)	Credit ($)
Cash Dr. Bonds Payable Premium on Bonds Payable	2,090,000	2,000,000 90,000

Face Value of bonds = $2,000,000

Issue Price of bonds = $2,090,000

Issue Price of each bond = Face Value of each bonds + Premium on each bond

$2,090,000 = $2,000,000 + Premium on each bond

Premium on each bond = $2,090,000 - $2,000,000

Premium on each bond = $90,000.

To determine

(b)

Introduction:

A bond is long term liability wherein the issuer is entitled to pay the face value of the bond at the time of maturity and make interest payments periodically. It is a breakdown of large debt to borrow as it may be too large for an individual lender.

To calculate:

Semi-annual interest payable on bonds.

Answer to Problem 70E

$57,000 will be paid as semi-annual interest on bonds.

Explanation of Solution

Given:

Bonds with face value of $2,000,000 sold for $2,090,000 with 6% stated rate.

If the bonds would have been issued at premium, then the Interest Expense for the period could have been calculated as:

Interest Expense (when bonds issued at premium) = Interest Expense − premium amortized

Similarly, in case of bonds issued at discount the interest expense is determined by adding the discount amortized for the period to the interest expense for the period.

Interest Payment (semi-annual) = $\$2,000,000\times 6\%\times \frac{6}{12}$

Interest Payment (semi-annual) = $60,000

Premium Amortization = Premium/No. of periods

Wherein, no. of periods = $15\times 2$ =30 (semi-annual interest)

So, Premium Amortization = $90,000/30

Premium Amortization = $3,000

Interest Expense (semi-annual) = Interest Payment - Premium Amortization

Interest Expense (semi-annual) = $60,000 - $3,000

Interest Expense (semi-annual) = $57,000.

To determine

(c)

Introduction:

A bond is long term liability wherein the issuer is entitled to pay the face value of the bond at the time of maturity and make interest payments periodically. It is a breakdown of large debt to borrow as it may be too large for an individual lender.

To record:

Journal entry for the recognizing interest expense and interest payment on bonds.

Answer to Problem 70E

Journal Entry to recognize interest and interest payment

Date	Particulars	Debit ($)	Credit ($)
30th June	Interest Expense Dr. Premium on Bonds Payable Dr. Cash	57,000 3,000	60,000

Explanation of Solution

Given:

Bonds with face value of $2,000,000 sold for $2,090,000 with 6% stated rate.

The borrower is entitled to pay interest periodically, unless stated otherwise.

As per the question, the interest is payable semi-annually on 30^th June and 31^st December.

Journal Entry to recognize interest and interest payment

Date	Particulars	Debit ($)	Credit ($)
30th June	Interest Expense Dr. Premium on Bonds Payable Dr. Cash	57,000 3,000	60,000

To determine

(d)

Introduction:

A bond is long term liability wherein the issuer is entitled to pay the face value of the bond at the time of maturity and make interest payments periodically. It is a breakdown of large debt to borrow as it may be too large for an individual lender.

To calculate:

Interest Expense for year 2020.

Answer to Problem 70E

The interest expense for year 2020 will be $114,000.

Explanation of Solution

Interest Expense (semi-annual) = $57,000

Bonds were issued on 1^st January 2020. This means there will be 2 semi-annual interest payments in the year 2020.

First interest payment will be made on 30^th June 2020 and the second on 31^st December 2020.

So, Interest Expense for year 2020 = $\text{2×Semi-annual interest expense}$

Interest Expense for year 2020 = $2\times \$57,000$

Interest Expense for year 2020 = $114,000.

To determine

(e)

Introduction:

A bond is long term liability wherein the issuer is entitled to pay the face value of the bond at the time of maturity and make interest payments periodically. It is a breakdown of large debt to borrow as it may be too large for an individual lender.

To critically think:

About Yield rate of floating rate bonds.

Answer to Problem 70E

Interest Expense would have been lower in case of bonds issued at premium.

Explanation of Solution

Floating Rate bonds are the bonds with variable interest rate.

Investors are attracted more towards the bonds with fixed interest rate as the interest payments won’t be fluctuating whereas interest rate and payment is unpredictable in case of floating rate bonds. Investors tend to earn a constant rate of return on their investment. Hence, they prefer fixed rate bonds over variable rate bonds. Thus, yield rate of bonds with variable interest rate is less as compared to bonds with fixed interest rate.

To determine

(f)

Introduction:

A bond is long term liability wherein the issuer is entitled to pay the face value of the bond at the time of maturity and make interest payments periodically. It is a breakdown of large debt to borrow as it may be too large for an individual lender.

To decide:

Whether bonds should be issued at fixed or variable rate.

Answer to Problem 70E

Firm should consider what level of financing is required to operate.

Explanation of Solution

Floating Rate bonds are the bonds with variable interest rate.

Investors are attracted more towards the bonds with fixed interest rate as the interest payments won’t be fluctuating whereas interest rate and payment is unpredictable in case of floating rate bonds.

Therefore, if the company require a huge sum of money then bonds should be issued at fixed rate as it will attract more investors and raising finance would become a comparatively easy task.

Although, if the firm require small amount from investors then they may issue bonds on variable interest rate. This will ultimately help them raise finances with variable interest payments liable on such debt (bonds).