1. United Alliance Inc. needs funds to acquire new equipment and the company decided to raise the funds through issuing bonds or shares. After considering current market situation and company financial position, United Alliance considers On June 30, 2017, the market interest rate is 7%. United Alliance issued $1,000,000 of 8%, 20-year bonds at 110.625. The bonds pay semi-annual interest on June 30 and December 31. United Alliance Inc. amortizes bonds by the effective-interest method.
a. Explain the difference between long term liability and equity financing. (10 marks
Record issuance of the bonds on June 30, 2017, the payment of interest at December 31, 2017, and the semi-annual interest payment on June 30, 2018. (20 Marks)
Please find below answer :
Part (a) Difference between long term liability and equity financing:
Ans: To raise capital for business needs, companies usually have two type of financing options: equity financing and debt financing. Most companies used the combination of two.
When financing a company, cost is the measurable cost of obtaining capital. With long term debt this is interest expenses a company pay on its debt. With equity, the cost of capital refers to the claim on earning provided to shareholder for their ownership stake.
Differences
Debt financing involves the borrowing of money where as equity financing involves selling a portion of equity in company.
The main advantage of equity financing is that there is no obligation to repay the money raised through it.
Equity financing places no additional financial burden on the company, however the downside is dilution of owner's stake in company.
The main advantage of debt financing is that business owner does not give up control of the business as they do with equity financing.
Creditors looks favorably upon a relatively low debt to equity ratio, which benefits the company if it needs to access additional debt financing in the future.
Most of the startup's choose equity financing as method to raise capital.
Part B ( Journal Entry)
Journal Entry | ||||||||
Year | Particulars | Debit ($) | Credit ($) | |||||
June 30 2017 | Enrty to record issuance of bond | |||||||
Cash A/C ([email protected]%) | $ 1,106,250 | |||||||
To Premium on bond payable | $ 106,250 | |||||||
(1106250-1000000) | ||||||||
To Bond payable | $ 1,000,000 | |||||||
(Journal enntry to record the issunace of bond) | ||||||||
Enrty to record interest payment on using effective interest method | Note 1 | |||||||
Decmber 2017 | Interest Expenses A/C | $ 38,719 | Cash Paid | 40000 | (1000000*8%*1/2) | |||
Premium on Bond payable A/C | $ 1,281 | Interest payment | 38719 | (1106250*7%*1/2) | ||||
To Cash A/C | $ 40,000 | Premium on Bond payable amortization | 1281 | (40000-38719) | ||||
(Journal entry to record interest payment) | ||||||||
Enrty to record interest payment on using effective interest method | Note 2 | |||||||
"June 2018 | Interest Expenses A/C | $ 38,674 | Cash Paid | 40000 | (1000000*8%*1/2) | |||
Premium on Bond payable A/C | $ 1,326 | Interest payment | 38674 | ((1106250-1281)*7%*1/2)) | ||||
To Cash A/C | $ 40,000 | Premium on Bond payable amortization | 1326 | (40000-38674) | ||||
(Journal entry to record interest payment) |
1. United Alliance Inc. needs funds to acquire new equipment and the company decided to raise...
1. United Alliance Inc. needs funds to acquire new equipment and the company decided to raise the funds through issuing bonds or shares. After considering current market situation and company financial position, United Alliance considers On June 30, 2017, the market interest rate is 7%. United Alliance issued $1,000,000 of 8%, 20-year bonds at 110.625. The bonds pay semi-annual interest on June 30 and December 31. United Alliance Inc. amortizes bonds by the effective-interest method. a. Explain the difference between...
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United alliance inc need s funda to accrue aequipment and company decided to rates the funds through issue bonds and share
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