Question

A company issued 5%, 20 year bonds with a face value of $80 million on January 1 2018. The market yield for bonds of similar risk is 6%. Interest is paid semiannually.

a. What was the interest expense for the first year using the effective interest method?

b. What are the entries to record the interest payment and expense on June 30 2018 and December 31 2018?

Answer 1

a.

Interest expense for the first year

$       4.25

Million

Working:

# 1

Price of bond

=

=-pv(rate,nper,pmt,fv)

=

$    70.75

Million

Where,

rate

=

3%

nper

=

40

pmt

$          80

Million

*

5%*6/12

=

$       2.00

Million

fv

$          80

Million

# 2

Discount amortization table for year -1

(amounts are in million)

Semi annual period

Interest Expense

Cash Interest

Discount amortization

Unamortized discount

Carrying Value

0

$       9.25

$    70.75

1

$       2.12

$       2.00

$       0.12

$       9.12

$    70.88

2

$       2.13

$       2.00

$       0.13

$       9.00

$    71.00

Total

$       4.25

$       4.00

$       0.25

Note:

Interest expense

=

Carrying value at the end of last period * semi annual market interest rate

b.

Journal entries:

Date

Account titles and Explanation

Debit

Credit

June 30, 2018

Interest Expense

$       2.12

Cash

$       2.00

Discount on bonds payable

$       0.12

(To record interest payment)

December 31, 2018

Interest Expense

$       2.13

Cash

$       2.00

Discount on bonds payable

$       0.13

(To record interest payment)