Question

Problem 10-9AB Effective Interest: Amortization of bond premium LO P6 Ellis Company issues 8.0%, five-year bonds dated January 1, 2019, with a $600,000 par value. The bonds pay interest on June 30 and December 31 and are issued at a price of $651,185. The annual market rate is 6% on the issue date. Required:

1. Compute the total bond interest expense over the bonds' life.

2. Prepare an effective interest amortization table for the bonds’ life.

3. Prepare the journal entries to record the first two interest payments.

Answer 1

Ans 1 Total Bond Interest Expense Over Life of Bond: Amount repaid [S600000 x 8%)/2 x 10] $240,000 10 payment of Par Value at maturity $600,000 Total Repaid $840,000 $651,185 Less: amount borrowed Total Bond Interest Expense $188,815 Ans 2 The effective interest rate is also called as market rate. It is the investor's yield maturity. When the effective interest rate iss higher/Lower as compared bond coupon rate then, the bonds were issued at a discount/premium. The Discount/Premium is then amortised over the period of bond by using effective interest rate method. Under this method, interest expense is derived by multiplying the bond carrying value with the effective interest rate applicable when the bonds were issued. The difference between the interest expense and actual interest paid is the discount/premium which will be amortised Amortisation schedule (Effective Interest Method) Opening book Closing Book Interest Expense Amortisation of Bond Premium Interest Payment Date Balance Value Computation (D) (B)-(C) Computation (A)+(C)-(B) (A) (B) (C) (A) x 8 % /2 $651,185 1-Jan-19 [5651185 x(6 %/ 2)] [S646721 x(6 %/2)] [S642123 x(6%/2)] [S637387 x(6 %/2)] [S632509 x(6%/2)] [S627484 x(6 % / 2)] [S622309 x(6 % / 2)] [5616978 x(6 % / 2)] [$611487 x(6 % / 2)] S605832 x(6%/2)] $19,536 [S24000-$19536] $19,402 [$24000-$19402] $19,264 [S24000-$19264] $19,122 S24000-$19122] $18,975 [S24000-$18975] $18,825 S24000-$18825] $18,669 S24000-$18669] $18,509 S24000-$18509] $18,345 [S24000-$18345] $18,168 [$24000-$18168 ] $4,464 $4,598 30-Jun-19 $651,185 $646,721 $642,123 $637,387 $632,509 $24,000 $24,000 $24,000 $24,000 $24,000 $24,000 $24,000 $24,000 $24,000 $24,000 $646,721 $642,123 $637,387 $632,509 $627,484 31-Dec-19 $4,736 $4,878 30-Jun-20 31-Dec-20 30-Jun-21 $5,025 $5,175 $5,331 $5,491 $627,484 $622,309 $616,978 $611,487 $622,309 S616,978 $611,487 $605,832 31-Dec-21 30-Jun-22 31-Dec-22 $5,655 30-Jun-23 $5,832 $605,832 $600,000 31-Dec-23

Particulars 30-Jun-19 Interest Expense Debit Credit Ans 3 Date $19,536 $4,464 Premium on Bond Payable Cash $24,000 To Record interest payment and amortisation) 31-Dec-19 Interest Expense $19,402 $4,598 Premium on Bond Payable Cash $24,000 To Record interest payment and amortisation)