Question

On January 1, 20X1, PAR purchases $100,000 par value, 12 percent coupon rate (i.e., stated rate), 10-year bonds from ROM for $90,000. Interest on the bonds is payable on January 1 and July 1. The interest expense recognized by ROM and the interest income recognized by PAR each year include straight-line amortization of the discount. (For simplicity, we do not use the effective interest method. But the logic is the same.)

When are bonds issued at discount?

a.		When market rate is equal to coupon rate.
b.		When market rate is lower than coupon rate
c.		When market rate is higher than coupon rate.

2) For ROM, record entries related to bonds for 1/1/20X1 & 7/1/20X1.

3) For PAR, record entries related to bonds for 1/1/20X1.

Answer 1

• Bonds are issued at Discount:

Correct Answer Option ‘C’ When market rate is higher than coupon rate.

This is because if market rate is higher than coupon rate, the bonds become un-attractive to investors. In order to induce them, the bonds are issued at a price below the face value, that is, they are issued at discount to make the bonds attractive to investors.

• Question data:

Face Value = $ 100,000
issue price = $ 90,000
Discount = $ 10,000
Period = 10 years = 2 interest payment each year = 20 payments.

Discount to be amortised = $ 10,000 / 20 = $ 500

• Requirement 2

Date	Accounts title	Debit	Credit
1/1/20X1	Cash	$            90,000.00
	Discounts on Bonds payable	$            10,000.00
	Bonds Payable		$        100,000.00
	(Bonds issued at discount)
7/1/20X1	Interest expense	$              6,500.00
	Cash		$             6,000.00
	Discount on Bonds Payable		$                 500.00
	(Interest payment)

• Requirement 3

Date	Accounts title	Debit	Credit
1/1/20X1	Bonds Investment (or Investment in Bonds)	$          100,000.00
	Discounts on Bonds		$           10,000.00
	Cash		$           90,000.00
	(Investments in bonds made)