Financial Accounting
Financial Accounting
17th Edition
ISBN: 9781259692390
Author: Jan Williams, Susan Haka, Mark S Bettner, Joseph V Carcello
Publisher: McGraw-Hill Education
Question
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Chapter 10, Problem 6PA

a)

To determine

Prepare the Adjusting entries at December 31, 2018, and the journal entry to record the payment of bond interest on March 1, 2019, under each of the following assumptions.

1. The bonds were issued at 98. (Round to nearest dollar.)

2. The bonds were issued at 101. (Round to nearest dollar.)

a)

Expert Solution
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Explanation of Solution

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

Bond discount: Bond discount is the amount by which the selling price (or issue price or market price) of the bond is lower than the face value of the bond.

Bond premium: Bond discount is the amount by which the selling price (or issue price or market price) of the bond is more than the face value of the bond.

Prepare the Adjusting entries at December 31, 2018, and the journal entry to record the payment of bond interest on March 1, 2019:

1. The bonds were issued at 98. (Round to nearest dollar.)

DateAccount title and ExplanationPost Ref.

Debit

($)

Credit

($)

December 31, 2018Bond Interest Expense (1)2,693,334
Discount on Bonds Payable26,667
Bond Interest Payable2,666,667
(To record the adjusting entry for the year end December 31, 2018)
March 1, 2019Bond Interest Payable2,666,667
Bond Interest expense1,346,667
Discount on Bonds payable (2)13,334
Cash4,000,000
(To record semiannual bond interest payment and interest expense for two months)

Table (1)

December 31, 2018:

  • Bond interest expense (decreases the equity) is increased. Thus, it is debited.
  • Discount on bonds payable (contra liability account) is decreased. Thus, it is credited.
  • Bond interest payable (liability) is increased. Thus, it is credited.

March 1, 2019:

  • Bond interest payable (liability) is decreased. Thus, it is debited.
  • Bond interest expense (decreases the equity) is increased. Thus, it is debited.
  • Discount on bonds payable (contra liability account) is decreased. Thus, it is credited.
  • Cash (asset) is decreased. Thus, it is credited.

Working note:

Calculate the bond interest payable as on December 31, 2018:

 Bond Interest ($80,000,000×10%×[4÷12months])$2,666,667
Add: Discount amortization ($1,600,000×[4÷240months])26,667
Bond interest expense as on December 31, 2018$2,693,334

(1)

Table (2)

Calculate the discount amortization for 2 months (January, February):

Discount amortization=$1,600,000×(2÷240months)=$13,334 (2)

2. The bonds were issued at 101. (Round to nearest dollar.)

DateAccount title and ExplanationPost Ref.

Debit

($)

Credit

($)

December 31, 2018Bond Interest Expense (3)2,653,334
Premium on Bonds Payable13,333
Bond Interest Payable2,666,667
(To record the adjusting entry for the year end December 31, 2018)
March 1, 2019Bond Interest Payable2,666,667
Bond Interest expense1,326,667
Premium on Bonds payable (4)6,666
Cash4,000,000
(To record semiannual bond interest payment and interest expense for two months)

Table (3)

December 31, 2018:

  • Bond interest expense (decreases the equity) is increased. Thus, it is debited.
  • Premium on bonds payable (liability) is decreased. Thus, it is debited.
  • Bond interest payable (liability) is increased. Thus, it is credited.

March 1, 2019:

  • Bond interest payable (liability) is decreased. Thus, it is debited.
  • Bond interest expense (decreases the equity) is increased. Thus, it is debited.
  • Premium on bonds payable (liability) is decreased. Thus, it is debited.
  • Cash (asset) is decreased. Thus, it is credited.

Working note:

Calculate the bond interest payable as on December 31, 2018:

 Bond Interest ($80,000,000×10%×[4÷12months])$2,666,667
Less: Premium amortization ($800,000×[4÷240months])(13,333)
Bond interest expense as on December 31, 2018$2,653,334

(3)

Table (4)

Calculate the premium amortization for 2 months (January, February):

Premium amortization=$800,000×(2÷240months)=$6,666 (4)

b)

To determine

Compute the net bond liability at December 31, 2019, under assumptions 1 and 2.

b)

Expert Solution
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Explanation of Solution

Compute the net bond liability at December 31, 2019, under assumptions 1 and 2:

 Bonds issued at $98Bonds issued at $101
Bond payable $80,000,000 $80,000,000
Less: Discount on bonds payable (5) (1,493,333)
Add: Premium on bonds payable (6)   746,667
Net bond liability $78,506,667 $80,746,667

Table (5)

Therefore, the net bond liability $98 is $78,506,667 and at $101 is $80,746,667.

Working notes:

Calculate the discount amortized on bonds payable as on December 31, 2019:

Total discount on bonds payable ($80 million×($100$98) ÷$100)$1,600,000
Amount amortized in 2018($1,600,000×[4÷240months]) $26,667
Amount amortized in 2019 ($1,600,000×[12÷240months])80,000
Discount amortized as on December 31, 2018$106,667

(5)

Table (6)

Calculate the premium amortized on bonds payable as on December 31, 2019

Total discount on bonds payable ($80 million×($101$100) ÷$100)$800,000
Premium amortized in 2018($800,000×[4÷240months]) $13,333
Premium amortized in 2019 ($800,000×[12÷240months])40,000
Discount amortized as on December 31, 2018 $53,333

(6)

Table (7)

c)

To determine

Find the assumption in part (a), in which the investor’s effective rate of interest is higher, explain the same.

c)

Expert Solution
Check Mark

Explanation of Solution

Under the assumption 1 of part (a), the effective rate of interest would be higher because the investors will pay less for bonds with a given rate of interest, the higher the effective interest rate the investors’ will earn.

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