Question

Miss Water Company has 8% 1 year bonds payable that are on June 30, 2028 The brands are Read the rem onts done 2018 and Miss Water pus interesah mend December 31 Requirement 1. W the bonds beatae v ata premamaladh a r a on the theater the market is the bed whebu Requirement 2. Misi Waterhud 5400 000 of the bonds a. Record ance of the bends on June 30, 2018 Record debits for Rounda tion to the rest dotat the credits Select explanations on the l ine of them (a) Jun 30

Answer 1

1) When bond's coupon rate is 8%, if the market interest rate is 7%, the bonds will be issued at PREMIUM (at price higher than par value); When bond's coupon rate is 8%, if the market interest rate is 9%, the bonds will be issued at DISCOUNT (at price less than par value); Reason: --> There is an inverse relationship between bond's coupon rate and yield to maturity (is nothing but the reinvestment rate per period). --> It results inverse relation exists between bond price and bond's reinvestment rate per period too. --> If the yield to maturity is lower than coupon rate, bonds will be issued at premium (market price more than bond's par value) as the bonds will be demanded more among the investors; In the given case, coupon rate is 8% whereas the yield to maturity is 7%. Therefore, bonds will be issued at price higher than bond's par value, that is at premium. --> Bond's yield to maturity is nothing but the market interest rate or expected return on bond by investors. If the yield to maturity is higher than coupon rate, bonds will be issued at discount (market price less than bond's par value) to attract more customers; In the given case, coupon rate is 8% whereas the yield to maturity is 9%. Therefore, bonds will be issued at price less than bond's par value, that is at discount. --> If yield to maturity is equal to coupon rate, bonds will be issued at par obviously as both coupon rate and investor's expected return rate are equal which implies that bond's coupon rate exactly satisfies investors' expected return on such bonds.

2) Transact. Date Jun. 30, 2018 Account Titles and Explanation Cash Discount on bonds payable Bonds payable Debit $352,000 $48,000 Credit [$400000 x 88%] [Bal. Figure --> $400000 - $352000 = $48000] $400,000 [Face value of the bonds issued] NOTE: This bond is considered as 'issued at discount' because cash received is less than par value of the bonds issued. Under straight-line method, discount on bonds issued shall be amortized over bond's life equally at each semiannual interest payment date. Such amortization shall be adjusted against interest expense recorded for the period though cash payment towards coupons shall be on face value of the bonds at coupon rate agreed. Therefore, Transact. b) Debit $18,400 Date Account Titles and Explanation Dec. 31, Interest Expense 2018 Discount on bonds payable Cash Credit [Balancing Figure -->$16000 + $2400 = $18400] $2,400 [$48000 / (10 years x 2) = $48000 / 20 semiannuals = $2400] $16,000 ($400000 x 8% / 2 --> Semiannual coupon payable] c) Carrying amount of bonds at December 31, 2018: Long-Term Liabilities: Bonds Payable Less: Discount on Bonds Payable $400,000 $45,600 $354,400 [Unamortized discount balance = $48000 - $2400 = $45600]

Transact. Date Jun. 30, 2018 Debit $18,400 Account Titles and Explanation Interest Expense Discount on bonds payable Cash Credit [Balancing Figure --> $16000 + $2400 = $18400] $2,400 ($48000/(10 years x 2) = $48000 / 20 semiannuals = $2400] $16,000 ($400000 x 8% / 2 --> Semiannual coupon payable] NOTE: Under straight-line method, as discount is amortized equally each semiannual, interest expense recognized each semiannual will be same.