Question

Required (1) Assume the bonds are issued at 103 on June 1 to yield an effective inter- est rate of 10.1 percent. Prepare entries in journal form for June 1, 20x7, November 30, 20x7, and May 31, 20x8. (Round amounts to the nearest dollar.) 2. Assume the bonds are issued at 97 on June 1 to yield an effective interest rate of 10.9 percent. Prepare entries in journal form for June 1, 20x7. November 30, 20x7, and May 31, 20x8. (Round amounts to the nearest dollar.) user insight 3. Explain the role that market interest rates play in causing a premium in requirement 1 and a discount in requirement 2. LOS LOS Bonds Issued at a Discount and a Premium-Effective Interest Method s07 P8. Pakesh Corporation issued bonds twice during 20x7. The transactions were as follows: 20x7 Jan. 1 Apr. 1 Issued $2,000,000 of 9.2 percent, ten-year bonds dated January 1, 20x7, with interest payable on June 30 and December 31. The bonds were sold at 98.1, resulting in an effective interest rate of 9.5 percent. Issued $4,000,000 of 9.8 percent, ten-year bonds dated April 1, 20x7, with interest payable on March 31 and September 30. The bonds were sold at 101, resulting in an effective interest rate of 9.5 percent Paid semiannual interest on the January 1 issue and amortized the discount, using the effective interest method. Paid semiannual interest on the April 1 issue and amortized the premium, using the effective interest method. June 30 Sept. 30

Answer 1

Fair value
Semiannual Market rate = 9.5%/2							4.75%
Interest payment (Credit Cash) = Face value of bond * Coupon rate = 2000000*9.2%*6/12 = 92000
Interest Expense (Debit Interest Expense) = book value of Bond for previous period * Semiannual Market rate
Amortization of bond Discount (Credit Bond Discount) = Interest Expense - Interest payment
Debit Balance in Bond Discount = Debit Balance in Bond Discount for previous period - Amortization of bond Discount
Credit Balance in Bond Payable = Face value of bond
Book value of Bond = Credit Balance in Bond Payable - Debit Balance in Bond Discount
Bond Discount Amortization Table
Debit Balance in Bond Discount at end of retirement of bond payable must be Zero.
Period	Date	Interest payment	Interest Expense	Amortization of bond Discount	Debit Balance in Bond Discount	Credit Balance in Bond Payable	Book value of Bond
0					$        38,000	$        2,000,000	$        1,962,000
1	June 30, 20X7	$          92,000	$          93,195	$        1,195	$        36,805	$        2,000,000	$        1,963,195
2	Dec 31, 20X7	$          92,000	$          93,252	$        1,252	$        35,553	$        2,000,000	$        1,964,447

Fair value
Semiannual Market rate = 9.5%/2							4.75%
Interest payment (Credit Cash) = Face value of bond * Coupon rate = 4000000*9.8%*6/12 = 196000
Interest Expense (Debit Interest Expense) = book value of Bond for previous period * Market or Discounting rate
Amortization of bond premium (Debit Bond Premium) = Interest payment - Interest Expense
Credit Balance in Bond premium = Credit Balance in Bond premium for previous period - Amortization of bond premium
Credit Balance in Bond Payable = Face value of bond
Book value of Bond = Credit Balance in Bond premium + Credit Balance in Bond Payable
Bond Premium Amortization Table
Credit Balance in Bond premium at end of retirement of bond payable must be Zero.
Period	Date	Interest payment (Cash paid)	Interest Expense @ 5%	Amortization of bond premium	Credit Balance in Bond premium	Credit Balance in Bond Payable	Book (carrying) value of Bond
0					$        40,000	$        4,000,000	$        4,040,000
1	Sep 30, 20X7	$        196,000	$        191,900	$        4,100	$        35,900	$        4,000,000	$        4,035,900
2	Mar 31, 2015	$        196,000	$        191,705	$        4,295	$        31,605	$        4,000,000	$        4,031,605

Part 1

Journal entries
Date	General Journal	Debit	Credit
Jan 1, 20X7	Cash (2000000*98.1%)	1,962,000
	Discount on bond payable (2000000-1962000)	38,000
	Bond payable		2,000,000
	(To record issued of bond payable at discount.)
Apr 1, 20X7	Cash (4000000*101%)	4,040,000
	Bond payable		4,000,000
	Premium on bond payable (4040000-4000000)		40,000
	(To record issued of bond payable at Premium.)
June 30, 20X7	Interest expense	93,195
	Discount on Bond payable		1,195
	Cash		92,000
	(To record interest expense and amortization of bond Discount.)
Sep 30, 20X7	Interest expense	191,900
	Premium on bond payable	4,100
	Cash		196,000
	(To record interest expense and amortization of bond premium.)
Dec 31, 20X7	Interest expense	93,252
	Discount on Bond payable		1,252
	Cash		92,000
	(To record interest expense and amortization of bond Discount.)
Dec 31, 20X7	Interest expense (191705*3/6)	$            95,853
	Premium on bond payable (4295*3/6)	$              2,147
	Interest Payable (196000*3/6)		$          98,000
	(To record accrued interest expense and amortization of bond premium.) (Oct, Nov, and Dec = 3 months)
Mar 31, 20X8	Interest expense (191705*3/6)	$            95,852
	Premium on bond payable (4295*3/6)	$              2,148
	Interest Payable	$            98,000
	Cash		$        196,000
	(To record interest expense and amortization of bond premium.) (Jan, Feb, and Mar = 3 months)

Part 2a

Date	Amount
June 30, 20X7	$          93,195
Sep 30, 20X7	$        191,900
Dec 31, 20X7	$          93,252
Dec 31, 20X7 (Accrued)	$          95,852
Total interest expense in 20X7	$        474,199

Part 2b

Date	Amount
June 30, 20X7	$          92,000
Sep 30, 20X7	$        196,000
Dec 31, 20X7	$          92,000
Dec 31, 20X7 (Accrued)
Total cash paid for interest in 20X7	$        380,000

Part 2c

Total interest expense in 20X7 is $474,199. Therefore, profitability should be decreased by $474,199.

Total cash paid for interest in 20X7 is $380,000. Therefore, the liquidity should be decreased by $380,000.