Question

Bond Premium, Entries for Bonds Payable Transactions

Campbell Inc. produces and sells outdoor equipment. On July 1, Year 1, Campbell issued $52,500,000 of 10-year, 11% bonds at a market (effective) interest rate of 10%, receiving cash of $55,771,356. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year.

Required:

If an amount box does not require an entry, leave it blank.

1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, Year 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 premium, 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 premium, using the straight-line method. (Round to the nearest dollar.)

3. Determine the total interest expense for Year 1. Round to the nearest dollar.
$

4. Will the bond proceeds always be greater than the face amount of the bonds when the contract rate is greater than the market rate of interest?

5. Compute the price of $55,771,356 received for the bonds by using Exhibit 5 and Exhibit 7. (Round to the nearest dollar.) Your total may vary slightly from the price given due to rounding differences.

Present value of the face amount	$
Present value of the semi-annual interest payments	$
Price received for the bonds	$

Answer 1

Solution Face Value of Bonds Issue price of Bonds Premium on issue of Bonds ($55,771,356 - $52,500,000) Coupon (contact rate / stated rate) Interest rate Market interest rate Bond life Interest payment frequency Total no. of interest payment till maturity (10 Years x 2) $52,500,000 $55,771,356 $3,271,356 11% 10% 10 Years Semi-annual 20 Semi-annual interest payment = $52,500,000 x 11% x 6/12 = $2,887,500 Required 1.: Journal entry to record issuance of bonds on July 1, Year 1 Credit Debit $55,771,356 Date General Journal July 1, Year 1 Cash Bonds Payable Premium on Bonds Payable (To record issuance of bonds) $52,500,000 $3,271,356 Required 2(a & b).: Journal entry to record interest payment and amortization of bond premium Step-1 : Calculation of semi-annual interest expense using straight-line method Total interest payment during the entire Bond life ($2,887,500 x 10 Years x 2) Payment of face value on maturity of Bonds Less: Cash proceeds received on issue price of Bond Total Interest expense to be recognised during the entire Bond life $57,750,000 $52,500,000 ($55,771,356) $54,478,644 Solution Face Value of Bonds Issue price of Bonds Premium on issue of Bonds ($55,771,356 - $52,500,000) Coupon (contact rate / stated rate) Interest rate Market interest rate Bond life Interest payment frequency Total no. of interest payment till maturity (10 Years x 2) $52,500,000 $55,771,356 $3,271,356 11% 10% 10 Years Semi-annual 20 Semi-annual interest payment = $52,500,000 x 11% x 6/12 = $2,887,500 Required 1.: Journal entry to record issuance of bonds on July 1, Year 1 Credit Debit $55,771,3561 Date General Journal July 1, Year 1 Cash Bonds Payable Premium on Bonds Payable (To record issuance of bonds) $52,500,000 $3,271,356 Required 2(a & b).: Journal entry to record interest payment and amortization of bond premium Step-1 : Calculation of semi-annual interest expense using straight-line method Total interest payment during the entire Bond life ($2,887,500 x 10 Years x 2) Payment of face value on maturity of Bonds Less: Cash proceeds received on issue price of Bond Total Interest expense to be recognised during the entire Bond life $57,750,000 $52,500,000 ($55,771,356) $54,478,644 Semi-Annual Interest Expense to be recognised ($54,478,644 / 20 semi-annual periods) $2,723,932

Required 3.: Total interest expense for Year 1 In Year 1, only one interest payment date (i.e. December 31) shall fall. Interest expense recognised on December 31, Year 1 $2,723,932 Total interest expense for Year 1 $2,723,932 Required 4.: If the contact rate of interest on the bonds is greater than the market rate of interest, the bonds shall provide higher returns to the investor on their investment as compared to the market return, and hence the investor shall be willing to pay premium above the face value of the bonds to buy them. Therefore, the bond proceeds will always be greater than the face amount of the bonds when the contract rate is greater than the market rate of interest. Required 5.: Computation of issue price of bonds Semi-annual interest payment $2,887,500 Present value of an ordinary annuity of $1 for 20 periods at 5% 12.46221 Present value of Semi-annual interest payments ($2,887,500 x 12.46221) $35,984,631 Face value of bonds to be repaid at the time of maturity Present value of $1 for 20 periods at 5% Present value of payment made on maturity ($52,500,000 x 0.37689) $52,500,000 0.37689 $19,786,725 Issue price of Bonds $55,771,356 Note: Since, the interest payment is semi-annually, hence the period shall be twice (10 years x 2), and the interest rate shall be half (10%/2) to select/calculate the present value factor. Present value of an ordinary annuity of 1 for 20 periods at 5% can be calculated as under: Present value annuity factor (Excel formula) = PV(10%/2,10*2,-1,,0) = 12.46221 Present value of 1 for 20 periods at 5% can be calculated as under: Present value factor (Excel formula) = 1/(1+10%/2)^(10*2) = 0.37689 Present value of the face amount $19,786,725 Present value of the semi-annual interest payments $35,984,631 Price received for the bonds $55,771,356