Question

CA14-2. (Bond Theory: Price, Presentation, and Redemption) On March 1, 2017, Sealy Company sold its 5-year, $1,000 face value, 9% bonds dated March 1, 2017, at an effective annual interest rate (yield) of 11%. Interest is payable semiannually, and the first interest payment date is September 1, 2017. Sealy uses the effective-interest method of amortization. The bonds can be called by Sealy at 101 at any time on or after March 1, 2018.

Instructions

(a) 1.How would the selling price of the bond be determined?

(a) 2.Specify how all items related to the bonds would be presented in a balance sheet prepared immediately after the bond issue was    sold.

(b) What items related to the bond issue would be included in Sealy's 2017 income statement, and how would each be determined?

(c) Would the amount of bond discount amortization using the effective-interest method of amortization be lower in the second or third year of the life of the bond issue? Why

(d) Assuming that the bonds were called in and redeemed on March 1, 2018, how should Sealy report the redemption of the bonds on the 2018 income statement? (AICPA adapted)

Answer 1

(a) Selling Price of the bond of Sealy company

Selling price = Pv of cash flows + Pv of redemption value.

If its redemption is face value

then 1000 x PVIF ( 5 , 11 % ) + 45 ( PVIFA ( 10 , 5.5 % ) half yearly interest (semi annual interest payable)

1000 x .593 + 45 x 7.53

= 593 + 338

= $931

Price will be 931 or it will be at 7 % discount ( Approx)

As in question after March 1 2018 redemption will be at 101 at 1010/-

so if we consider above

Then bond price will be 1010 *.593 + 338= $938

(b): Amount which to be shown in Financial statement after the bond issued .

Bond price $ 938

Discount : $ 62 per bond

it is assumed that 100 bond has been issued

price received : 100 *938 = $93800

Discount on issue of bond : $6200

Premium on redemption of bond which to be paid $ 10 per bond = $1000

Statement of Financial Position of Sealy Company on 1st March 2017

Share Capital And Liabilities

9% Bond $100000

premium on redemption of bond $ 1000

$ 101000

Assets

Current Assets:

Bank $ 93800

Misc Assets

Discount on issue of bond $6200

Loss on issue of bond $1000

$101000

(c) Amortization on the basis of effective interest rate .

Payment is semi annual so effective rate will be 1.055 x 1.055-1 = 11.30$

but there is also interest payment so calculation will be as follow

Year	Opening	Interest	payment	Closing
1	93800	5159	4500	94459
	94459	5196	4500	95155
2	95155	5233	4500	95888
	95888	5273	4500	96661
3	96661	5316	4500	97477
	97477	5361	4500	98338

(d) If bond redeemed on 01/03/2018 after one year at a price of 101 % = 101000

Income Statement of Sealy Company

Interest on bond : 5159+5196 = $10355

Loss on bond and Discount on bond = $ 1000+ 6200 - 1355* =5845

* 10355 -9000 = 1355