Question

During Year 1 and Year 2, Agatha Corp. completed the following transactions relating to its bond issue. The corporation’s fiscal year is the calendar year. Year 1 Jan. 1 Issued $330,000 of 8-year, 8 percent bonds for $324,000. The annual cash payment for interest is due on December 31. Dec. 31 Recognized interest expense, including the straight-line amortization of the discount, and made the cash payment for interest. Dec. 31 Closed the interest expense account. Year 2 Dec. 31 Recognized interest expense, including the straight-line amortization of the discount, and made the cash payment for interest. Dec. 31 Closed the interest expense account. Required a-1. When the bonds were issued, was the market rate of interest more or less than the stated rate of interest? a-2. If Agatha had sold the bonds at their face amount, what amount of cash would Agatha have received? b. Prepare the liabilities section of the balance sheet at December 31, Year 1 and Year 2. c. Determine the amount of interest expense that will be reported on the income statements for Year 1 and Year 2. d. Determine the amount of interest that will be paid in cash to the bondholders in Year 1 and Year 2.

Answer 1

Solution:

Issue Price of the bonds = $324,000

Face Value of the bonds = $330,000

Issue price is less than the face value, it means the bonds are issued at discount.

Discount on Bonds Payable = $330,000 – 324,000 = $6,000

It is given that the discount on bonds payable is amortized using straight line basis over the life of the bonds.

Periods to maturity = 8 years

Annual straight line amortization = Discount on Bonds Payable 6,000 / Periods of Maturity 8 = $750

Coupon Interest Rate = 8%

Annual Coupon Interest Payable = Face Value $330,000 * Coupon Interest 8% = $24,600

Annual Interest Expenses related to bonds = Cash Interest payable $24,600 + Annual Bond Discount Amortization $750

= $25,350

Date	General Journal	Debit	Credit
Dec.31, Year 1	Interest Expense	$25,350
	Cash Interest Payable		$24,600
	Discount on Bonds Payable (Amortization)		$750
	(being interest expenses recorded)
Dec.31, Year 1	Cash Interest Payable	$24,600
	Cash		$24,600
	(Being Interest paid)
Dec.31, Year 1	Income Summary	$25,350
	Interest Expense		$25,350
	(Interest Expense closed to Income Summary)
Dec.31, Year 2	Interest Expense	$25,350
	Cash Interest Payable		$24,600
	Discount on Bonds Payable (Amortization)		$750
	(being interest expenses recorded)
Dec.31, Year 2	Cash Interest Payable	$24,600
	Cash		$24,600
	(Being Interest paid)
Dec.31, Year 2	Income Summary	$25,350
	Interest Expense		$25,350
	(Interest Expense closed to Income Summary)

Part a-1 – Bonds are issued at the price lower than face value of bonds. It means the investor has to pay less amount to purchase bonds than its face value. Hence, the bonds are issued at discount i.e. less than the coupon rate.

It means the market interest rate is less than its stated rate of interest.

Part a-2 – If the bonds had sold at their face amount, the amount of cash would Agatha have received = Face value of the bonds = $330,000

Part b --

Balance Sheet (partial) at the end of Year 1
Long Term Borrowings:
Bonds Payable (face Value)	$330,000
Less: Discount on Bonds Payable (Unamortized)	-$5,250
Carrying Value of the Bonds	$324,750

Balance Sheet (partial) at the end of Year 2
Long Term Borrowings:
Bonds Payable (face Value)	$330,000
Less: Discount on Bonds Payable (Unamortized)	-$4,500
Carrying Value of the Bonds	$325,500

Part c –

Interest Expense that would be reported in

Year 1 = $25,350

Year 2 = $25,350

Part d – Amount of interest that will be paid in cash to the bond holders in

Year 1 = $24,600

Year 2 = $24,600

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you