Question

Part 1:

On January 1 2018, Louis Company issued bonds with a Par Value of $400,000. The coupon interest rate on the bond is 10%, and it has a maturity of 3 years.

Interest is paid semiannually on June 30^th and December 31 of each year.

Required:

Compute the value of the bond assuming the following market rates of interest:

                                                                                                            [5 points]

Value of Bond @ 8% =   _____________________________________ Value of Bond @10% = _____________________________________

Part 2:

From part 1, using the effective interest method, show how the bond premium would be amortized over the life of the bond. Fill in the following table to do this. Please round any amounts to the nearest $.

	A	B	C	D	E
Interest Date	Cash Interest Payment	Interest Expense	Premium Amortization	Premium A/C Balance	Bond Carrying Amount
1/1/2018
6/30/2018
12/31/2018
6/30/2019
12/31/2019
6/30/2020
12/31/2020

Part 3:

Show journal entries for the premium bond for the following:

The issue of the bond on January 1^st, 2018

(ii)        The first and second interest dates (June 30^th, 2018 and December 31^st, 2018)

[10 points]

1/1/18	Account Name	Debit	Credit

6/30/18	Account Name	Debit	Credit

12/31/18	Account Name	Debit	Credit

Answer 1

Solution

Louis Company

Computation of value of bond assuming the following market rates of interest:

• Value of bond at 8% =

Value of bonds = present value of bonds + present value of interest

Face value of bonds = $400,000

Semiannual interest payments

Period = 3 years x 2 = 6 periods

Semiannual Interest payment = 400,000 x 10% x 6/12 = $20,000

Effective market rate = 8%/2 = 4%

Present value of bonds = 400,000 x (P/F, 4%, 6)

= 400,000 x 0.7903 = $316,120

Present value of interest = 20,000 x (P/A, 4%, 6)

= 20,000 x 5.242 = $104,840

Value of bonds = 316,120 + 104,840 = $420,960

Hence, value of bonds at 8% market rate of interest = $420,960

The bond is sold at premium, = 420,960 – 400,000 = $20,960

• Market interest rate of 10%

Value of bonds = present value of bonds + present value of interest

Face value of bonds = $400,000

Semiannual interest payments

Period = 3 years x 2 = 6 periods

Semiannual Interest payment = 400,000 x 10% x 6/12 = $20,000

Effective market rate = 10%/2 = 5%

Present value of bonds = 400,000 x (P/F, 5%, 6)

= 400,000 x 0.7462 = $298,480

Present value of interest = 20,000 x (P/A, 5%, 6)

= 20,000 x 5.076 = $101,520

Value of bonds = 298,480 + 101,520 = $400,000

Hence, value of bonds at 10% market rate of interest = $400,000

At, 10% market rate of interest, the bond issue price = par value = $400,000

Part 2:

Schedule showing amortization of bond premium using the effective interest method:

Interest Date	Cash Interest Payment	Interest Expense	Premium Amortization	Premium Balance	Bond Carrying Amount
1/1/2018	0	0	$20,960	$20,960	$420,960
6/30/2018	$20,000	$16,838	$3,162	$17,798	$417,798
12/31/2018	$20,000	$16,712	$3,288	$14,510	$414,510
6/30/2019	$20,000	$16,580	$3,420	$11,090	$411,090
12/31/2019	$20,000	$16,444	$3,556	$7,534	$407,534
6/30/2020	$20,000	16,301	$3,699	$3,835	$403,835
12/31/2020	$20,000	$16,153	$3,847	$0	$400,000

The amounts have been rounded to nearest dollars.

Entries:

Date	Account Titles and Explanation	Ref. No.	Debit	Credit
1/1/2018	Cash		$420,960
	Premium on Bonds Payable			$20,960
	Bonds Payable			$400,000
	(To record issue of bonds)
6/30/2018	Interest Expense		$16,838
	Premium on Bonds Payable		$3,162
	Cash			$20,000
	(To record semiannual interest payment)
12/31/2018	Interest Expense		$16,712
	Premium on Bonds Payable		$3,288
	Cash			$20,000
	(To record semiannual interest payment)