Question

McWherter Instruments sold $400 million of 10% bonds, dated January 1, on January 1, 2021. The bonds mature on December 31, 2040 (20 years). For bonds of similar risk and maturity, the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Blanton Technologies, Inc., purchased $400,000 of the bonds as a long-term investment. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. Determine the price of the bonds issued on January 1, 2021. 2. Prepare the journal entries to record (a) their issuance by McWherter and (b) Blanton's investment on January 1, 2021. 3. Prepare the journal entries by (a) McWherter and (b) Blanton to record interest on June 30, 2021 (at the effective rate). 4. Prepare the journal entries by (a) McWherter and (b) Blanton to record interest on December 31, 2021 (at the effective rate).

Answer 1

Solution:

1)

Interest	$ 20,000,000 x 15.04630 (see note 1)	$ 300,926,000
Principal	$ 400,000,000 x 0.09722 (see note 2)	$ 38,888,000
Present value of bonds	Total	$ 339,814,000

Note 1:

Interest calculation = $ 400,000,000 x 10% x (6/12) = $ 20,000,000

Present value of an ordinary annuity of $1: n = 40, i = 6% (PVA of $1) = 15.04630

Note 2:

Present value of $1: n = 40, i = 6% (PV of $1) = 0.09722

2) Bonds will be issued at discount because the present value of inflows is less than the face value. The Discount on bonds account should be amortized to interest expense over the life of the bond. The amortization will cause the bond value to increase from $ 339,814,000 on January 1, 2021 to $ 400,000,000 just prior to maturing of bond on December 31,2040

a) Journal entry for Issuance of bonds

Date	Journal	Debit	Credit
Jan 1, 2021	Cash	$ 339,814,000
	Discount on bonds (Balancing Fig.)	$ 60,186,000
	Bonds Payable		$ 400,000,000
	(Being bonds issued by McWherter at present value of bonds)

b) Journal entry for Blanton's Investment

Date	Journal	Debit($)	Credit($)
Jan 1, 2021	Investment in bonds	400,000
	Discount on bond investment (Balancing Fig.)		60,186
	Cash ( 0.1% x $ 339,814,000)		339,814
	(Being $400,000 bonds purchased which is 0.1% of the total value of bonds issued )

3) We record interest expense at effective rate of interest which is the market rate of interest. Here it is 6% for each semi - annual period. However the corporation must make an interest payment of 5% per semi annual period.The difference between the above two amounts will be the amortization.

Journal entry to record interest expense on June 30, 2021

a)

Date	Journal	Debit($)	Credit($)
June 30, 2021	Interest Expense ( 6% of  $ 339,814,000)	20,388,840
	Discount on bonds (Balancing Fig.)		388,840
	Cash ( 5% x $ 400,000,000)		20,000,000
	(Being interest paid at 10% for 6 months i.e,at 5% and interest expense charged at market yield , difference used to write off the discount on bonds )

b)

Date	Journal	Debit($)	Credit($)
June 30, 2021	Cash ( 5% of 400,000)	20,000
	Discount on bond investment (Balancing Fig.)	389
	Interest Revenue ( 6% of 339,814)		20,389
	(Being interest received at 10% for 6 months i.e,at 5% and interest revenue realized at market yield , difference used to write off the discount on bonds )

4)

a)

Date	Journal	Debit($)	Credit($)
December 31, 2021	Interest Expense [6% of  $ (339,814,000 + 388,840)]	20,412,170
	Discount on bonds (Balancing Fig.)		412,170
	Cash ( 5% x $ 400,000,000)		20,000,000
	(Being interest paid at 10% for 6 months i.e,at 5% and interest expense charged at market yield , difference used to write off the discount on bonds )

b)

Date	Journal	Debit($)	Credit($)
December 31, 2021	Cash ( 5% of 400,000)	20,000
	Discount on bond investment (Balancing Fig.)	412
	Interest Revenue [ 6% of (339,814 + 389)]		20,412
	(Being interest received at 10% for 6 months i.e,at 5% and interest revenue realized at market yield , difference used to write off the discount on bonds )