Chapter 14, Problem 1E

To determine

Issue of bond at par:

When the coupon rate or contract rate of a bond is equal to the market interest rate, the bond is being issued at par value. If a bond is issued at par, the selling price of the bond will be equal to face value of the bond.

Issue of bond at discount:

When the coupon rate or contract rate of a bond is lower than the market interest rate, the bond is being issued at discount. The selling price of the bond will be lower than the face value of the bond under issue of bond at discount.

Issue of bond at premium:

When the coupon rate or contract rate of a bond is higher than the market interest rate, the bond is being issued at premium. If the bond is issued at premium, the selling price of the bond will be higher than the face value of the bond.

To determine:

1. Computation of the semiannual interest on the bonds payable.

2. Journalizing the (a) issuance of bonds on January 1, 2017; (b) the first interest payment on June 30, 2017; and (c) the second interest payment on December 31, 2017

3. Preparation of journal entry for issuance assuming the bonds are issued at (a) 98 and (b) 102.

Answer to Problem 1E

Solution:

1.

Boston Enterprise will pay an interest amount of $153,000 semiannually.

2.

Date	General Journal	Debit	Credit
2015
Jan. 1	Cash	$3,400,000
	Bonds Payable		$3,400,000
Jun. 30	Interest Expense	$153,000
	Cash		$153,000
Dec. 31	Interest Expense	$153,000
	Cash		$153,000

3.

Date	General Journal	Debit	Credit
2015
Jan. 1	Cash	$3,332,000
	Discount on Bonds Payable	$68,000
	Bonds Payable		$3,400,000
Jan. 1	Cash	$3,468,000
	Premium on Bonds Payable		$68,000
	Bonds Payable		$3,400,000

Explanation of Solution

Explanation:

1.

Computation of semiannual interest on Bonds Payable

Bonds Par Value		Semiannual Rate		Semiannual Interest Payment
$3,400,000	X	4.5%	=	$153,000

2.

When a bond is issued, cash is received by the issuer and the bonds payable becomes a liability for the issuer. So cash accounts is debited as the cash comes into the business and bond payable accounts credited as the it is liability which has to paid back on maturity.

Interest expense is an expense for the bond issuer, so when interest is paid on bonds payable, the interest expense accounts is debited as it is expense and the cash account is credited as the cash goes out of business.

3.

Bonds issued at discount:

Discount on bonds issued is an expense, so the when bonds are issued at discount, cash is debited excluding the discount, discount on bonds payable is debited being an expense and bonds payable accounts is credited as it is liability for the business unless it is paid.

Computation of discount on bonds issued.

Bonds Par Value		Issue Price in percent		Bonds Carrying Value
$3,400,000	X	98%	=	$3,332,000

$\begin{array}{l}DiscountonBondsPayable=BondsParValue–Bonds\text{ Issue}\text{}\text{}\text{}\text{ }\text{Price}\hfill \\ =\$3,400,000-\$3,332,000\hfill \\ =\$68,000\hfill \end{array}$

Bonds issued at premium:

Premium on bonds is revenue, hence when bonds are issued on premium, cash is debited including the premium and premium on bonds payable account and bonds payable accounts are credited.

Computation of premium on bonds issued.

Bonds Par Value		Issue Price in percent		Bonds Carrying Value
$3,400,000	X	102%	=	$3,468,000

$\begin{array}{l}\text{Premium }onBondsPayable=BondsParValue–Bonds\text{ Issue}\text{}\text{}\text{}\text{ }\text{Price}\hfill \\ =\$3,400,000-\$3,468,000\hfill \\ =\$68,000\hfill \end{array}$

Conclusion

Bonds payable are usually issued in denomination $100, so if it is issued at $98 it means the issue is on discount of $2 and if it is issued at $102 it means the issue is on premium of $2.