Question

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On the first day of its fiscal year, Ebert Company issued $53,500,000 of 10-year, 7% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market feffective) interest rate of 8%, resulting in Ebert receiving cash of $49,864,758. The company uses the interest method. Required: a. Journalize the entries to record the following transactions. Refer to the Chart of Accounts for exact wording of account titles. 1. Sale of the bonds on January 1. 2. First semiannual interest payment on June 30, including amortization of discount. Round to the nearest dollar. 3. Second semiannual interest payment on December 31, including amortization of discount. Round to the nearest dollar. b. Compute the amount of the bond interest expense for the first year. c. Explain why the company was able to issue the bonds for only $49,864,758 rather than for the face amount of $53,500,000 CHART OF ACCOUNTS Ebert Company General Ledger ASSETS 110 Cash 111 Petty Cash 121 Accounts Receivable 122 Allowance for Doubtful Accounts 126 Interest Receivable 127 Notes Receivable REVENUE 410 Sales 610 Interest Revenue 611 Gain on Redemption of Bonds EXPENSES 510 Cost of Merchandise Sold 515 Credit Card Expense 516 Cash Short and Over

Answer 1

Ans a Date Credit Liabilities Equity Jan 1 Debit $49,864,758 $3,635,242 Assets $49,864,758 ($3,635,242) $53,500,000 $53,500,000 June 30 $1,994,590 ($1,994,590) Description Post. Ref Cash Discount on Bond Payable Bond Payable (To record issue of bond at discount) Interest Expense Discount on Bond Payable Cash (To record interest payment) Interest Expense Discount on Bond Payable Cash (To record interest payment) $122,090 $122,090 $1,872,500 ($1,872,500) Dec 31 $1,999,474 ($1,999,474) $126,974 $126,974 $1,872,500 ($1,872,500)

The effective interest rate is also called as market rate. It is the investor's yield maturity. When the effective interest rate is higher/Lower as compared bond coupon rate then, the bonds were issued at a discount/premium. The Discount/Premium is then amortised over the period of bond by using effective interest rate method. Under this method, interest expense is derived by multiplying the bond carrying value with the effective interest rate applicable when the bonds were issued. The difference between the interest expense and actual interest paid is the discount/premium which will be amortised. Amortisation schedule (Effective Interest Method) Cash Payment Amortisation Opening book Interest Closing Date $53500000 x of Bond Balance Expense Book Value 7%/2 Discount (C) =(A) (A) (B) (D)=(C)-(B) (A)+(C)-(B) 8%/2 Jan 1 $49,864,758 Jun 30 $49,864,758 $1,872,500 $1,994,590 $122,090 $49,986,848 Dec 31 $49,986,848 $1,872,500 $1,999,474 $126,974 $50,113,822 $3,745,000 $3,994,064 $249,064 Ansb Annual Interest paid Discount amortised Interest Epense for the year $3,745,000 $249,064 $3,994,064 Ansc The bonds sell for less than their face amount because the market interest rate is higher than the contract rate of interest. Investors are not willing to pay full face amount of bonds that pay a lower contract rate of interest than they could earn on similar bonds (market rate)