Question

On January 1, 2019, Drennen Inc. issued $5 million face amount of 10-year, 14% stated rate bonds when market interest rates were 12%. The bonds pay semiannual interest each June 30 and December 31 and mature on December 31, 2028.

a. Calculate the proceeds (issue price) of Drennen Inc.'s bonds on January 1, 2019, assuming that the bonds were sold to provide a market rate of return to the investor. (Round PV factor to 4 decimal places.)

b-1. Assume instead that the proceeds were $4,820,000. Use the horizontal model to record the payment of semiannual interest and the related discount amortization on June 30, 2019, assuming that the discount of $180,000 is amortized on a straight-line basis. Indicate the financial statement effect.

b-2. Assume instead that the proceeds were $4,820,000. Record the journal entry to show the payment of semiannual interest and the related discount amortization on June 30, 2019, assuming that the discount of $180,000 is amortized on a straight-line basis.(If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

c. If the discount in part b were amortized using the compound interest method, would interest expense for the year ended December 31, 2019, be more than, less than, or equal to the interest expense reported using the straight-line method of discount amortization?

Multiple Choice

• Interest expense will be less.

• Interest expense will be more.

• Interest expense will be the same.

Answer 1

Answer-a- The semiannual interest on the bonds= stated rate* face amount *6/12

=14%*$5,000,000*6/12

=$350,000

The semiannual market interest rate = 12%*6/12

=6%

The present value of an interest annuity is calculated by multiplying the value if semiannual interest by the present value annuity factor of $1 for 20 periods at 6% of the discount rate.

The value of the present value annuity factor of $1 for 20 periods at 6% of the discount rate is 11.4699 as extracted from table 6-5

PV of an interest annuity = Amount of semiannual interest *present value annuity factor of $1 for 20 periods at 6% of discount rate

=$350,000*11.4699

=$4,014,465

The present value of an interest annuity is calculated by multiplying the value if semiannual interest by the present value annuity factor of $1 for 20 periods at 6% of the discount rate.

The value of the present value annuity factor of $1 for 20 periods at 6% of the discount rate is 0.3118 as extracted from table 6-4

PV of maturity value= Future maturity value of bonds * Present value factor of $1

=$5,000,000 *0.3118

=$1,559,000

Proceeds of the bonds= PV of interest + PV of maturity value

=$4,014,465+$1,559,000

=$5,573,465

b-1-For the given transactions, the horizontal model that shows the effects of the given transactions and adjustments as shown bel0w:-

Transactions	Balance Sheet	Income Statement
	Assets= Liabilities+ Stockholders' Equity	Net Income= Revenues-Expenses
	Cash-$35,000 Discount on bonds payable +$9,000	Interest expenses-$359,000

b-2-

Event	General Journal	Debit	Credit
	Interest Expenses	359,000
	Discount on bonds payable		9,000
	Cash		350,0000

cThe amortization of the discount on bonds payable is treated as a credit balance, and thus added to interest expense. Using the straight line method, the amount of discount amortization is equal for each period/ year. Under the compound interest basis, the discount amortization amount rises each period. Accordingly, interest expense using the compound method is lower in the first years of the estimated life of the bonds and higher in late years as compared to that evaluated under the straight line basis of amortization.