Question

E14-1 On Jan 1 2019 LCM1 issued a 5 year $700,000 Bond paying 9% interest semi-annually. The market rate for bonds of similar risk and maturity was 10%. LCM uses the straight-line method amortization. Journalize the LCM1 Issue Cr. Dr. Jan 1 Cash Bond Issue Disc Bond Journalize the interest payment made by LCM June 30 2019 Cr. Dr. Jun 30 Interest Payment

Answer 1

On the issue of the bonds, if the interest rate for bonds with similar risk and maturity in the market increases, then the corporation has to record the issue of bonds at a discount as per the market rate for similar bonds. The discount is treated as an additional interest expense to be recorded over the lifetime of the bonds. Over the time period of the bonds, the discount on bonds recorded in the books must be reduced to zero.

In the current case, LCM1 is issuing bonds for 5Year at 9% semi-annually $ 700,000 on 1 Jan. 2019. The interest payment will be $31,500($700,000 * 9% * 6/12) on each June 30 and Dec. 31.

Now, since the entity is issuing the bond at 9% and the similar bonds are available at 10% interest, LCM1 will receive less than the bonds face value. Let’s assume that the bonds are sold for $ 673,050 on January 1, 2019. LCM1 would record the issue of bonds as follows,

Jan 1	Bond Issue	Dr.	Cr.
	Cash	673,050
	Discount on Bonds Payable	26,950
	Bonds Payable		700,000

Now, using the straight-line method of amortization, the discount on bonds would be reduced to zero during the life period of bonds. The discount would be treated as an additional interest expense over the life of the bonds. The straight-line amortization would be $5,390 ($26,950/5 years).

LCM1 would record the interest expense along with the amortization of discount on bonds as follows,

Jun 30	Interest Payment	Dr.	Cr.
	Interest Expense	34,195
	Discount on bonds payable		2,695
	Cash		31,500