Chapter 10, Problem 10.7PA

1.

To determine

To prepare: Abond amortization schedule.

Explanation of Solution

Amortization Schedule: An amortization schedule is a table that shows the details of each loan payment allocated between the principal amount and the overdue interest along with the beginning and ending balance of the loan. From the amortization schedule of the loan, the periodical interest expense, total interest expense and total payment made are known.

Prepare bond amortization schedule as below:

Bond discount amortization schedule – Effective- Interest Amortization Method
Year Ending December 31	Interest Expense (Carrying value x 4%) (A)	Cash Paid (Face value x 3%) (B)	Discount Amortized (C) =(A-B)	Bonds Payable (D)	Discount on Bonds Payable (E)	Carrying Value (F) = (D-E)
01/01/15	-	-	-	600,000	16,648	583,352
12/31/15	23,334	18,000	5,334	600,000	11,314	588,686
12/31/16	23,547	18,000	5,547	600,000	5,767	594,233
12/31/17	23,767 (rounded)	18,000	5,767	600,000	0	600,000

Table (1)

Working note:

Calculate discount on bonds payable on 01/01/15.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\begin{array}{l}\text{Face value }\\ -\text{ Cash received}\end{array}\right)\\ =\$600,000-\$583,352\\ =\$16,648\end{array}$

Discount on bonds payable for each period is calculated by the following formula:

$\text{Discount on bonds payable = Previous balance of discount on bonds payable}–\text{Discount amortized}$

2.

To determine

To prepare: Journal entry to record the issuance of the bonds on January 1, 2015.

Explanation of Solution

Bonds: Bonds are long-term promissory notes that are represented by a company while borrowing money from investors to raise fund for financing the operations.

Bonds Payable: Bonds payable are referred to long-term debts of the business, issued to various lenders known as bondholders, generally in multiples of $1,000 per bond, to raise fund for financing the operations.

Discount on bonds payable: It occurs when the bonds are issued at a low price than the face value.

Effective-interest amortization method: Effective-interest amortization methodit is an amortization model that apportions the amount of bond discount or premium based on the market interest rate.

Prepare journal entry for cash proceeds from the issuance of the bonds on January 1, 2015.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
January 1, 2015		Cash				583,352
		Discount on Bonds Payable				16,648
			Bonds Payable				600,000
				(To record issuance of bonds payable at discount)

Table (2)

• Cash is an asset and it is increased. So, debit it by $583,352.
• Discount on Bonds Payable is an adjunct liability account and itis decreased. So, debit it by $16,648.
• Bonds payable is a liability and it is increased. So, credit it by $600,000.

Working note:

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\begin{array}{l}\text{Face value }\\ -\text{ Cash received}\end{array}\right)\\ =\$600,000-\$583,352\\ =\$16,648\end{array}$

3.

To determine

To prepare: Journal entry to record the interest payment on December 31, 2015.

Explanation of Solution

Prepare journal entry for payment of interest and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31, 2015		Interest Expense				23,334
			Discount on Bonds Payable				5,334
			Cash				18,000
				(To record payment of interest and amortization of discount on bonds)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $23,334.
• Discount on Bonds Payable is an adjunct liability account and itis increased. So, creditit by $5,334.
• Cash is an asset and it is decreased. So, credit it by $18,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$600,000\times 3\%\times 1\\ =\$18,000\end{array}$

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\$583,352\times 4\%\times 1\\ =\$23,334\end{array}$

Calculate discount amortized.

$\begin{array}{c}\text{Discount amortized}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$23,334-\$18,000\\ =\$5,334\end{array}$

To determine

To prepare: Journal entry to record the interest payment on December 31, 2016.

Explanation of Solution

Prepare journal entry for payment of interest and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31, 2016		Interest Expense				23,547
			Discount on Bonds Payable				5,547
			Cash				18,000
				(To record payment of interest and amortization of discount on bonds)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $23,547.
• Discount on Bonds Payable is an adjunct liability account and itis increased. So, creditit by $5,547.
• Cash is an asset and it is decreased. So, credit it by $18,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$600,000\times 3\%\times 1\\ =\$18,000\end{array}$

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$583,352+\$5,334\right)\times 4\%\times 1\\ =\$23,547\end{array}$

Calculate discount amortized.

$\begin{array}{c}\text{Discount amortized}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$23,547-\$18,000\\ =\$5,547\end{array}$

4.

To determine

To prepare: Journal entry to record the interest and face value payment on December 31, 2017.

Explanation of Solution

Prepare journal entry for payment of interest and face value.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
December 31, 2017		Interest Expense				23,767
		Bonds Payable				600,000
			Discount on Bonds Payable				5,767
			Cash				618,000
				(To record payment of interest and face value)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by 23,767.
• Bonds payable is a liability and it is decreased. So, debit it by $600,000.
• Discount on Bonds Payable is an adjunct liability account and itis increased. So, creditit by $5,767.
• Cash is an asset and it is decreased. So, credit it by $618,000.

Working notes:

Calculate cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$600,000\times 3\%\times 1\\ =\$18,000\end{array}$

Calculate interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$583,352+\$5,334+\$5,547\right)\times 4\%\times 1\\ =\$23,767\end{array}$

Calculate discount amortized.

$\begin{array}{c}\text{Discount amortized}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$23,767-\$18,000\\ =\$5,767\end{array}$

5.

To determine

To prepare: Journal entry to record the bond retirement on January 1, 2017.

Explanation of Solution

Retirement of Bonds: The process of repaying the sale amount of bonds to bondholders at the time of maturity or before the maturity period is called as retirement of bonds. It is otherwise called as redemption of bonds.

Prepare Journal entry to record the bond retirement on January 1, 2017.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
January 1, 2017		Bonds Payable				600,000
		Loss on Retirement of Bonds				11,767
			Discount on Bonds Payable				5,767
			Cash				606,000
				(To record the retirement of the bonds)

• Bonds payable is a liability and it is decreased. So, debit it by $600,000.
• Loss on retirement of bonds is an equity account and it is decreased. So, debit it by $11,767.
• Discount on Bonds Payable is an adjunct liability account and itis increased. So, creditit by $5,767.
• Cash is an asset and it is decreased. So, credit it by $606,000

Working note:

Determine the gain or loss on the retirement of the bonds.

Step 1: Calculate carrying amount of bonds payable on the retirement.

$\begin{array}{c}\text{ Carrying amount of bonds payable = }\left(\begin{array}{l}\text{Face value }\\ -\text{Unamortized discount }\end{array}\right)\\ =\$600,000-\$5,767\\ =\$594,233\end{array}$

Step 2: Compute loss on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Loss on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Cash paid to retire }\\ \text{the bonds}\end{array}\right)-\left(\begin{array}{l}\text{Carrying amount }\\ \text{of bonds payable}\end{array}\right)\\ =\left(\$600,000\times 101\%\right)-\$594,233\\ =\$606,000-\$594,233\\ =\$11,767\end{array}$