Question

On 1/1/2001, ABC Co. issued $1,000,000 5-year bonds with a market rate of 8%. Interests are paid annually on 12/31. The coupon rate is 6%. Answer the following questions assuming that the company uses the effective interest method of amortization. Show your calculations. 1. Determine the selling price of the bond on the issue date. Is it issued at a premium or discount? 2. Give the journal entry to record the bond issuance above. 3. How much is the interest expense for ABC Co. for the fiscal year that ended 12/31/2001? Give the journal entry to record the interest expense. 4 . On 1/1/2003, ABC Co. found itself with a lot of excess cash and it will be best for them to buy back their bonds from the open market and retire them so as to avoid future interest payments. The market interest rate on 1/1/2003 is 9%. Calculate: (i) the cash amount that ABC has to pay to retire the bond (ii) the book value (i.e., net borrowing) of the bonds on 1/1/2003 (iii) gain/loss from the retirement (iv) provide the journal entry for the early retirement of bonds.

Answer 1

1
Selling Price of bonds:
	Amount	PV Factor	Present value
Interest	60000	3.99271	239563
Principal	1000000	0.68058	680580
Selling Price of bonds			920143
Selling price is less than bond price. Therefore the bonds are issued at a discount.
2
01-01-2001	Cash		920143
	Discount on Bonds payable		79857
	Bonds Payable			1000000
	To record Bonds issue
3
Interest expense for 2001 = 920143*8% = $73,611
12/31/2001	Interest Expense		73611
	Discount on Bonds payable			13611
	Cash			60000
	To record Interest expense
4 (i)
	Amount	PV Factor	Present value
Interest	60000	2.5313	151878
Principal	1000000	0.77218	772180
Cash ABC have to pay to retire the bond			924058
4 (ii)
Bond Payable			1000000
Less: Discount on Bond Payable			51546
Net Book Value			948454
4 (iii)
	Bond Payable		1000000
	Cash			924058
	Discount on Bond			51546
	Gain on Retirement			24396