Bond discount, entries for bonds payable transactions
On July 1, Year 1, Danzer Industries Inc. issued $40,000,000 of 10-year, 7% bonds at a market (effective) interest rate of 8%, receiving cash of $37,282,062. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year.
Instructions
1.
2. Journalize the entries to record the following:
A. The first semiannual interest payment on December 31, Year 1, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.)
B. The interest payment on June 30, Year 2, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.)
3. Determine the total interest expense for Year 1.
4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest?
5. (Appendix 1) Compute the price of $37,282,062 received for the bonds by using the present value tables in Appendix A at the end of the text. (Round to the nearest dollar.)
1.
Bonds: Bonds are long-term promissory notes that are represented by a company while borrowing money from investors to raise fund for financing the operations.
Bonds Payable: Bonds payable are referred to long-term debts of the business, issued to various lenders known as bondholders, generally in multiples of $1,000 per bond, to raise fund for financing the operations.
Discount on bonds payable: It occurs when the bonds are issued at a low price than the face value.
Straight-line amortization method: It is a method of bond amortization that spreads the amount of the bond discount equally over the interest period.
To prepare: Journal entry to record the amount of cash proceeds from the issuance of the bonds on July 1, Year 1.
Answer to Problem 11.1APR
Prepare journal entry for cash proceeds from the issuance of the bonds on July 1, Year 1.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
July 1, Year 1 | Cash | 37,282,062 | |||||
Discount on Bonds Payable (1) | 2,717,938 | ||||||
Bonds Payable | 40,000,000 | ||||||
(To record issuance of bonds payable at discount) | |||||||
Table (1)
Explanation of Solution
- Cash is an asset and it is increased. So, debit it by $37,282,062.
- Discount on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $2,717,938.
- Bonds payable is a liability and it is increased. So, credit it by $40,000,000.
Working note:
Calculate discount on bonds payable.
2.
A.
To prepare: Journal entry to record first interest payment and amortization of bond discount on December 31, Year 1.
Answer to Problem 11.1APR
Prepare journal entry for first interest payment and amortization of discount on bonds.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
Year 1 | Interest Expense (4) | 1,535,897 | |||||
December | 31 | Discount on Bonds Payable (2) | 135,897 | ||||
Cash (3) | 1,400,000 | ||||||
(To record semiannual payment of interest and amortization of discount on bonds) | |||||||
Table (2)
Explanation of Solution
- Interest expense is an expense and it decreases the equity value. So, debit it by $1,535,897.
- Discount on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $135,897.
- Cash is an asset and it is decreased. So, credit it by $1,400,000.
Working notes:
Calculate discount on bonds payable semiannually.
Calculate the amount of cash interest.
Calculate the interest expense on the bond.
B.
To prepare: Journal entry to record second interest payment and amortization of bond discount on June 30, Year 2.
Answer to Problem 11.1APR
Prepare journal entry for second interest payment and amortization of discount on bonds.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
Year 2 | Interest Expense (7) | 1,535,897 | |||||
June | 30 | Discount on Bonds Payable (5) | 135,897 | ||||
Cash (6) | 1,400,000 | ||||||
(To record semiannual payment of interest and amortization of discount on bonds) | |||||||
Table (3)
Explanation of Solution
- Interest expense is an expense and it decreases the equity value. So, debit it by $1,535,897.
- Discount on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $135,897.
- Cash is an asset and it is decreased. So, credit it by $1,400,000.
Working notes:
Calculate discount on bonds payable semiannually.
Calculate the amount of cash interest.
Calculate the interest expense on the bond.
3.
The amount of total interest expense for Year 1.
Explanation of Solution
Determine the amount of total interest expense for Year 1.
Hence, the amount of total interest expense for Year 1 is $1,535,897.
4.
To explain: The situation when contract rate of bond is less than the market rate of interest.
Answer to Problem 11.1APR
Yes, the bond proceeds will always be less than the face amount of bonds when the contract interest rate is less than the market interest rate.
Explanation of Solution
If the stated interest rate of a bond is less than the market interest rate, then the bonds is issued at discount. This is because the bonds is less valuable in market and investors is ready to pay less than the maturity value of bonds.
5.
To calculate: The amount of cash proceeds (present value) from the sale of the bonds using present value tables.
Explanation of Solution
Determine the amount of cash proceeds (present value) from the sale of the bonds.
Step 1: Calculate the semiannual interest on bonds.
Step 2: Calculate the present value of interest.
Particulars | Amount |
Interest payment (a) | $1,400,000 |
PV factor at semiannual market interest rate of 4% for 20 periods (b) | 13.59033 |
Present value
|
$19,026,462 |
Table (4)
Note: Refer Appendix A in the text book for present value factor.
Step 3: Calculate the present value of lump sum payment of $80,000,000 (principal amount) at 4% for 20 periods.
Particulars | Amount |
Single payment (a) | $40,000,000 |
PV factor at semiannual market interest rate of 4% for 20 periods (b) | 0.45639 |
Present value
|
$18,255,600 |
Table (5)
Note: Refer Appendix A in the text book for present value factor.
Step 4: Calculate the amount of cash proceeds from the sale of the bonds.
Thus, the amount of cash proceeds from the sale of the bonds is $37,282,062.
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Chapter 11 Solutions
Corporate Financial Accounting
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