Question

On 1 January 2019, Oscar Ltd issued 10-year bonds with a face amount of $20,000,000 and a contract rate of 8%, with interest payable annually starting 1 January 2020. The effective interest rate on the date of issuance was 10%. Required: a) Prepare the journal entry for the bond issuance, and explain why the bonds will be issued at less than face value. b) Oscar Ltd has an annual accounting period ending on 31 March 2019. Prepare the adjusting entry required on that date. c) Prepare the journal entry for the first interest payment on 1 January 2020. (Hint: Do not forget about b).) d) Assuming the bonds are redeemed at maturity, what is the total amount of interest expense to be recognised over the life of the bonds? e) Assume the bonds are redeemed before maturity at an amount greater than their face value. i. Discuss if the market interest rate on the date of redemption was less than, equal to, or greater than the contract rate. Justify your answer using present value concepts. No calculations are required. ii. Assume that on the date of redemption, the carrying value of the bonds was less than the cash paid. 1) Prepare the journal entry for the redemption, using XXX in place of figures. What follows, in an unrelated example, is what is meant by using XXX: Cash XXX Loss on Sale of Land XXX Land XXX 2) Should the gain/loss from the bond redemption be classified as Other Comprehensive Income? If not, why not?

Answer 1

Answer to Requirement a.

Face Value = $20,000,000

Annual Coupon Rate = 8%
Annual Coupon = 8% * $20,000,000
Annual Coupon = $1,600,000

Annual Interest Rate = 10%
Time to Maturity = 10 years

Issue Value = $1,600,000 * PVA of $1 (10%, 10) + $20,000,000 * PV of $1 (10%, 10)
Issue Value = $1,600,000 * 6.14457 + $20,000,000 * 0.38554
Issue Value = $17,542,112

The Bonds are issued at less than face value because the market rate of interest i.e. 10% is higher than the coupon rate of 8%.

Answer to Requirement b Account Titles and Explanation Interest Expense ($17,542,112 * 10% * 3/12) Interest Payable ($20,000,000 * 896 * 3/12) Discount on Bonds Payable Debit Credit Date Mar 31, 438,553 2019 400,000 38,553 To record Interest accrued Answer to Requirement c Account Titles and Explanation | Interest Expense ($17,542,112 * 10% * 9/12) Interest Payable Cash ($20,000,000 * 896) Discount on Bonds Payable To record Interest payment and amortization of Debit Credit Date Jan 1, 1,315658 2020 438,553 1,600,000 154,211 discount Answer to Requirement d Interest expenses to be recognized at the maturity of Bonds $18,457,888

Interest Paid Interest ExpenseDiscount Unamortized Carrying Value Period Ended @ 10% on CV | Amortized 8% on FV Discount 01/01/2019 17,542,112 2,457,888 01/01/2020 1,754,21:1 17,696,323 1,600,000 154,211 2,303,677 01/01/2021 1,600,000 1,769,632 169,632 2,134,044 17,865,956 01/01/2022 1,786,596 18,052,551 1,600,000 186,596 1,947,449 01/01/2023 1,600,000 1,805,255 205,255 1,742,194 18,257,806 01/01/2024 1,825,781 1,600,000 225,781 1,516,413 18,483,587 248,359 01/01/2025 1,600,000 1,848,359 1,268,055 18,731,945 01/01/2026 1,873,195 1,600,000 273,195 994,860 19,005,140 01/01/2027 1,600,000 1,900,514 300,514 694,346 19,305,654 01/01/2028 1,930,565 1,600,000 330,565 363,781 19,636,219 01/01/2029 1,600,000 1,963,781 363,781 20,000,000