Question

Week 2 a) What factors should be considered in determining the issue price of a debenture. (2 marks) b) On 1 July 2018 Bombo Ltd issues $2 million in six-year debentures that pay interest each six months at a coupon rate of 8 per cent. At the time of issuing the securities, the market requires a rate of return of 6 per cent. Interest expense is determined using the effective-interest method. Required: (1) Determine the issue price of the debenture. (2 marks) (ii) Provide the journal entries at: (6 marks) 1 July 2018, 30 June 2019, & 30 June 2020.

Answer 1

Answer :

a) In determination of issue price of a Debenture the interest rate of debenture and market interest rate shall be considered. If the interest rate of the debenture is more than the market interest rate then the debentures will be issued at premium.If the interest rate of the debenture is less than the market interest rate then the debentures will be issued at discount. If the interest rate of the debenture is equal to  the market interest rate then the debentures will be issued at Face value.

b)

(i) Calculation of issue price of debenture

Issue price of Debenture   = Present Value of face value debenture + Present Value of Interest

Face value of Debentures = $ 2,000,000

Market interest rate = 6% annually = 3% semi-annually

No of periods = 6 x 2 = 12

Present Value of face value debenture = 2,000,000 / (1+3%)^12 = 2,000,000 / 1.42576 = $ 1,402,760

Interest Payment = $ 2,000,000 x 8% = $ 160,000 annually = $80,000 semi-annually

Present Value of Interest = $80,000 x [ ( 1 - ( 1 + 3% )^-12 ) / 3% ] = 80000 x [ ( 1- 0.701379) / 3%]

= 80000 x 9.954 = $ 796,320

Issue price of Debenture = $ 1,402,760 +  $ 796,320 = 2,199,080

(ii) Journal entries at: 1 July 2018, 30 June 2019, & 30 June 2020.

Date	Particulars	Debit	Credit
1 July 2018	Cash	$2,199,080
	Premium on Debenture		$199,080
	Debenture Payable		$2,000,000
	( To record the issue of debentures)
30-Jun-19	Interest Expense	$63,410
	Premium on Debenture	$16,590
	Cash /Interest Payable		$80,000
	( To record the interest expense as on 30 June,2019
30-Jun-20	Interest Expense	$63,410
	Premium on Debenture	$16,590
	Cash /Interest Payable		$80,000
	( To record the interest expense as on 30 June,2020)

Notes : Calculation of amortized amount of premium on debentures

Premium on the Debenture = $2,199,080 - $2,000,000 = $199,080

Amortization period = 12

Amortization per period = $199,080 / 12 = $16,590 every six months

Interest Expense = Interest Payment - Amortization amount of premium = $80,000 - $16,590 = $63,410