Question

The Bradford Company issued 8% bonds, dated January 1, with a face amount of $50 million on January 1, 2021 to Saxton-Bose Corporation. The bonds mature on December 31, 2030. For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.

1. Prepare the journal entry to record the purchase of the bonds by Saxton-Bose on January 1, 2021.

2. Prepare the journal entry to record interest for Saxton-Bose on June 30, 2021.

3. Prepare the journal entry to record interest for Saxton-Bose on December 31, 2021.

Answer 1

Answer:

When a company issues bonds, it incurs a long term liability on which periodic interest payments must be made, usually twice a year. The party who purchase these bonds will treat it as Investment in Bonds and will receive Interest income.
Hence, before passing the journal entries we calculate the interest payments and Price of Bonds:

Price of Bonds = Present Value of Principal + Present Value of Interest Payments

Interest to be paid each period is determined by coupon rate for that period and the present value calculation is based on market interest rates.

In the above question:

Market Interest Rate = 10%

For Semi-annual rate = 10%/2 = 5%, rate = 5%

For Semi- annual periods = 20 , n = 20 (Its 10 year bond therefore for semi annual periods 10 * 2)

Present Value of Principal = $ 50 million * Present value factor for single payment (5% , 20 periods)

= $ 50 million * 0.3769 = $ 18.845 million

Interest Payment  each semi annual period = $ 50 million * 4% ( coupon rate for semi annual period 8%/2 = 4%)

= $ 2 million

Present value of Interest Payments:

Interest Payment each semi-annual period * Present value factor for an ordinary entity (5% , 20 periods)

= ( $ 50 million * 4%) * 12.4622 = $ 24.9244

1) Record the Journal entry for the Purchase of Bonds by Saxton - Bose on January 1,2021

Date	Account	Debit (in million)	Credit (in million)
January 1,2021	Investment in Bonds A/c Dr	$ 50
	To Cash / Bank		$ 50

2) Record Journal entry for Interest:

Date	Account	Debit (in million)	Credit (in million)
June 30, 2021	Interest Receivable A/c Dr	$ 24.9244
	To Interest Revenue		$ 24.9244
December 31,2021	Interest Receivable A/c Dr	$ 24.9244
	To Interest revenue		$ 24.9244