Question

03 L05 Bond Transactions—Effective Interest M 7. Khan Corporation has $20,000,000 of 10.5 percent, 20-year bonds dated Tune 1, 20x7 with interest payment dates of May 31 and November 30. The company's fiscal year ends November 30. It uses the effective interest method to amortize bond premiums or discounts. Required 2 metrologo 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.) 3. Explain the role that market interest rates play in causing a premium in requirement 1 and a discount in requirement 2. Fight

Answer 1

1 x fc i ДА В face value of bonds semiannual coupon rate semiannual coupon payment semiannual market rate semiannual interest periods issue price of bonds $ 20,000,000 5.25% $ 1,050,000 5.05% 40 $ 20,600,000 date june 1, 20x7 november 30, 20x7 may 31, 20x8 amortization schedule interest expense interest payment premium amortization carrying value of bonds $ 20,600,000 | $ 1,040,300 $ 1,050,000 $ 9,700 $ 20,590,300 $ 1,039,810 $ 1,050,000 $ 10,190 $ 20,580,110 journal account titles and explanation date debit credit june 1, 20x7 $ 20,600,000 cash bonds payable premium on bonds payable (issue of bonds recorded) $ 20,000,000 $ 600,000 november 30, 20x7 $ 1,040,300 $ 9,700 interest expense premium on bonds payable cash (interest expense recorded) $ 1,050,000 may 31, 20x8 $ 1,039,810 $ 10,190 interest expense premium on bonds payable cash (interest expense recorded) $ 1,050,000

B34 | x fc 2 AA B с H 2 face value of bonds semiannual coupon rate semiannual coupon payment semiannual market rate semiannual interest periods issue price of bonds $ 20,000,000 5.25% $ 1,050,000 5,45% 40 $ 19,400,000 date june 1, 20x7 november 30, 20x7 may 31, 20x8 amortization schedule interest expense interest payment discount amortization carrying value of bonds I $ 19,400,000 $ 1,057,300 $ 1,050,000 $ 7,300 $ 19,407,300 $ 1,057,698 $ 1,050,000 $7,698 $ 19,414,998 journal account titles and explanation debit credit june 1, 20x7 $ 19,400,000 $ 600,000 cash discount on bonds payable bonds payable (issue of bonds recorded) $ 20,000,000 november 30, 20x7 $ 1,057,300 interest expense discount on bonds payable cash interest expense recorded) $ 7,300 $ 1,050,000 may 31, 20x8 $ 1,057,698 interest expense discount on bonds payable cash (interest expense recorded) $ 7,698 $ 1,050,000

1 x fc 1 ДА В DE G H In (1), The interest rate offered by the company of 10.5% is more than the market expectation of 10.1% The company is paying more than what market expects, hence the investors are ready to pay more than the face value, hence the bonds are issued at a premium. In (2), The interest rate offered by the company of 10.5% is less than the market expectation of 10.9% The company is paying less than what market expects, hence the investors are ready to pay less than the face value, hence the bonds are issued at a discount.

for formulas and calculations, refer to the image below -

* fax 1 B2 : 4 AB face value of bonds 20000000 semiannual coupon rate = 10.5%/2 semiannual coupon payment =D2*D3 semiannual market rate =10.1%/2 semiannual interest periods =20*2 issue price of bonds =D2 103% date june 1, 20x7 november 30, 20x7 may 31, 20x8 amortization schedule interest expense interest payment premium amortization carrying value of bonds =D7 =G11*$D$5 =$D$4 =E12-D12 =G11-F12 =G12*$D$5 =$D$4 =E13-D13 =G12-F13 journal account titles and explanation date debit credit june 1, 20x7 =D7 cash bonds payable premium on bonds payable (issue of bonds recorded) =D2 =F18-619 november 30, 20x7 =D12 =F12 interest expense premium on bonds payable cash (interest expense recorded) may 31, 20x8 =D13 =F13 interest expense premium on bonds payable cash (interest expense recorded)

B34 face value of bonds 20000000 semiannual coupon rate =10.5%/2 semiannual coupon payment =D34*D35 semiannual market rate =10.9%/2 semiannual interest periods =20*2 issue price of bonds =D34*97% date june 1, 20x7 november 30, 20x7 may 31, 20x8 amortization schedule interest expense interest payment discount amortization carrying value of bonds =D39 =G43*$D$37 =$D$36 =D44-E44 =G43+F44 | =G44*$D$37 =$D$36 =D45-E45 =G44+F45 journal account titles and explanation date debit credit june 1, 20x7 =D39 =G52-F50 cash discount on bonds payable bonds payable issue of bonds recorded) =D34 november 30, 20x7 =D44 interest expense discount on bonds payable cash (interest expense recorded) =F44 =E44 may 31, 20x8 =D45 interest expense discount on bonds payable cash (interest expense recorded) =F60-G62 =E45

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