Question

On June 30, 2020, Stellar Company issued $4,380,000 face value of 14%, 20-year bonds at $5,039,020, a yield of 12%. Stellar uses the effective-interest method to amortize bond premium or discount. The bonds pay semiannual interest on June 30 and December 31. Prepare the journal entries to record the following transactions. (Round answer to decimal places, eg. 38,548. If no entry is required, select "No Entry" for the account titles and enter for the amounts. Credit account titles are automatically indented when amount is entered. Do not indent manually) (1) The issuance of the bonds on June 30, 2020. (2) The payment of interest and the amortization of the premium on December 31, 2020. (3) The payment of interest and the amortization of the premium on June 30, 2021. (4) The payment of interest and the amortization of the premium on December 31, 2021.

please help me answering these question with explaination/steps on how to do it please . thank you so much.

Answer 1

Solution

Stellar Company

Journal entries related to bond issue:

Account Titles and Date Explanation Ref. No. Debit Credit 30-June- 2020 Cash $5,039,020 Bonds Payable $4,380,000 Premium on Bonds $659,020 (To record issue of bonds at premium) 31-Dec- 2020 Interest Expense $302,341 Premium on Bonds $4,259 Cash $306,600 (Payment of interest, premium amortization and interest expense) 30-June- 2021 Interest Expense $302,086 Premium on Bonds $4,514 Cash $306,600 (Interest expense, premium amortization, cash payment) Dec 31, 2021 Interest Expense $301,815 Premium on Bonds Payable $4,785 Cash $306,600 (To record interest expense and premium

Notes:

1. Premium on bonds –

Face value of bonds = 4,380,000

Issued price = $5,039,020

Premium on bonds = 5,039,020 – 4,380,000 = $659,020

2. Interest payment on Dec 31, 2020 = 4,380,000 x14% x 6/12 = $306,600

Interest expense = 5,039,020 x 12% x 6/12 = $302,341

premium amortization = $306,600 – 302,341 = $4,259

Balancing amount is interest expense, 15,500 – 310 = 15,190

3. Interest expense at June 30, 2021 = carrying value of bond x 12% x 6/12

Carrying value of bond – beg. Balance – premium amortization

Carrying value of bond = 5,039,020 – 4,259 = $5,034,761

So, interest expense = 5,034,761 x 6% = $302,086

Cash payment = $306,600

Premium amortization = $306,600 – 302,086 = $4,514

4. Interest expense at Dec 31, 2021 = carrying value of bond x 12% x 6/12

Carrying value = 5,034,761 – 4,514 = $5,030,247

Interest expense = 5,030,247 x 6% = $301,815

Cash payment = $306,600

Premium amortization = 306,600 – 301,815 = $4,785

Balance sheet presentation for the liability for the bonds payable on the December 31, 2021 balance sheet:

Stellar Company Balance Sheet (Partial) At December 31, 2021 Long-term Liabilities Bonds Payable Add: Unamortized premium on bonds payable $4,380,000 $645,462 $5,025,462

Calculation of unamortized premium on bonds payable –

Premium on bonds payable = $659,020

Less: amortized premium ( 4,259 + 4,514 + 4,785) = 13,558

Unamortized premium on bonds payable = $645,462

1. What amount of interest expense is reported for 2021 –

Interest expense for 2021 = interest expense on June 30 + interest expense on Dec 31

Interest expense on June 30 = $302,086

Interest expense on Dec 31 = $301,815

Amount of interest expense reported for 2021 = 302,086 + 301,815 = $603,901

2. Will the bond interest expense reported in 2021 be the same as, greater than, or less that the amount that would be reported if the straight line method of amortization were used:

The bond interest expense reported in 2021 will be More than the amount that would be reported if the straight lime method of amortization were used.

Computations –

Premium amortization under straight line method = $659,020/(20x2) periods = $16,475

Cash payment = $306,600

Interest expense for each semi-annual period would be = 306,600 – 16,475 = 290,125

The interest expense reported under effective interest method for first and the next two semi-annual periods is more than 300,000. Hence, the bond interest expense reported under straight line method of amortization for 2021 = 290,125 x 2 = $580,250

The interest expense reported under effective interest method for 2021 = $603,901

Hence, interest expense reported under effective interest method (603,901) is higher than the interest expense reported under straight line amortization method.

3. Total cost of borrowing over the life of the bond –

Total cash interest payment – total premium on bonds payable

= (306,600 x 40) – 659,020 = $11,604,980

4. The total bond interest expense for the life of the bond would be the same as the total interest expense if the straight-line method of amortization were used.