Question

On January 1, a company issues bonds dated January 1 with a par value of $550,000. The bonds mature in 5 years. The contract rate is 6%, and interest is paid semiannually on June 30 and December 31. The market rate is 7 % and the bonds are sold for $527119. The journal entry to record the second interest payment using the effective interest method of amortization is

Answer 1

There is a discount in the bond issuance, since the market rate (7%) is higher than the contract rate (6%). There are 2 payments (of interest) in each year and there are 5 years; therefore, the total number of payments is (2 × 5 =) 10.

Effective (market) rate = 7% / 2 = 3.5%

Contract (sated) rate = 6% / 2 = 3%

Amount of discount = Par value – Sale price

                                    = 550,000 – 527,119

                                    = 22,881

Date	Int. payment (550000 × 3%) Cash	Int. Exp. 3.5% × Beginning BV	Amort. Of discount	Bond discount	Bond. payable	BV
Jan 1				22881	550000	550000 – 22881 = 527119
Jun 30	16,500	527119 × 3.5% = 18,449	18449 – 16500 = 1,949	22881 – 1949 = 20,932	550000	550000 – 20932 = 529068
Dec 31	16,500	529068 × 3.5% = 18,517	18517 – 16500 = 2,017	22881 – 2017 = 20864	550000	550000 – 20864 = 529136

Journal

Date	Account titles and explanation	Ref.	Debit	Credit
Dec. 31	Interest expense		$18,517
	Discount on bonds payable			$2,017
	Cash			$16,500
	To record semi-annual interest payment.