Question

1.

A corporation issues $500,000 of 20-year, 7% bonds dated January 1 at 95. The journal entry to record the issuance will include

Group of answer choices

a credit to Bonds Payable for $500,000.

a credit to Premiums on Bonds Payable for $25,000.

a debit to Interest Expense for $25,000.

a credit to Discount on Bonds Payable for $25,000.

a debit to Cash for $500,000.

2.

If the market interest rate for a bond is higher than the stated interest rate, the bond will sell at

Group of answer choices

the conversion rate

a premium.

the termination rate

a discount.

par.

Answer 1

1) A corporation issues $500,000 of 20-year, 7% bonds dated January 1 at 95. The journal entry to record the issuance will include a debit to Cash for $500,000 and a credit to Bonds Payable for $500,000.

The journal entry for the above transaction will be

Cash a/c - dr $500000
To bonds Payable $500000

2) If the market interest rate for a bond is higher than the stated interest rate, the bond will sell at a discount.

Explanation -  Bonds on the secondary market with fixed coupons will trade at discounts when market interest rates rise. While the investor receives the same coupon, the bond is discounted to match prevailing market yields.

Let's examine the effects of higher market interest rates on an existing bond by first assuming that a corporation issued a 9% $100,000 bond when the market interest rate was also 9%. Since the bond's stated interest rate of 9% was the same as the market interest rate of 9%, the bond should have sold for $100,000.

Next, let's assume that after the bond had been sold to investors, the market interest rate increased to 10%. The issuing corporation is required to pay only $4,500 of interest every six months as promised in its bond agreement ($100,000 x 9% x 6/12) and the bondholder is required to accept $4,500 every six months. However, the market will demand that new bonds of $100,000 pay $5,000 every six months (market interest rate of 10% x $100,000 x 6/12 of a year). The existing bond's semiannual interest of $4,500 is $500 less than the interest required from a new bond. Obviously the existing bond paying 9% interest in a market that requires 10% will see its value decline.