Explain the journal entry made to pay the semi-annual interest and amortize the premium on bonds...

Explain the journal entry made to pay the semi-annual interest and amortize the premium on bonds payable using the effective interest method. Don't forget to explain how the numbers for each debit and credit are determined for each period.

Expert Solution

Solution:

To explain journal entry to pay semiannul interest and amortize the premium on bond payable using the effective interest method, let consider following example.

Face value of bond issue = $100,000

Coupon rate = 10%, 5% semi annual

Market rate = 8% per annum

Period to maturity = 2 years, 4 semi annual period.

As coupon rate of interest is higher than market rate of interest, therefore bond will be issued at premium. Now first we compute, issue price of bond.

Bond issue price is equal to present value of interest payment and maturity amount discounted at market rate of interest.

Computation of bond price
Table values are based on:
n=	4
i=	4%
Cash flow	Table Value	Amount	Present Value
Par (Maturity) Value	0.85480	$100,000	$85,480
Interest (Annuity)	3.62990	$5,000	$18,149

Price of bonds			$103,630

Now bond issue price = $103,630

Premium on issue of bond = Issue price - Par value = $103,630 - $100,000 = $3,630

Now to prepare journal entry to pay semiannul interest and amortize premium on bond payable, we first prepare bond amortization to calculate amount of premium amortized using effective interest method each semiannual period.

Bond Amortization Schedule
Semiannual period	Interest paid	Interest expense (4%)	Premium Amortized	Unamortized Premium	Carrying Value
Issue Date				$3,630	$103,630
1	$5,000	$4,145	$855	$2,775	$102,775
2	$5,000	$4,111	$889	$1,886	$101,886
3	$5,000	$4,075	$925	$962	$100,962
4	$5,000	$4,038	$962	$0	$100,000

Amount premium amortized is equal to difference between interest paid and interest expense using effective interest method. Interest expense is determined on carrying value of bond multiplying with market rate of interest.

Now following journal entry will be prepared to record semiannual interest.

Journal Entries
Period	Particulars	Debit	Credit
1	Interest Expense Dr	$4,155.00
	Premium on bond Payable Dr	$845.00
	To Cash		$5,000.00
	(To record semiannual interest payment and Premium Amortization)

2	Interest Expense Dr	$4,111.00
	Premium on bond Payable Dr	$889.00
	To Cash		$5,000.00
	(To record semiannual interest payment and Premium Amortization)

3	Interest Expense Dr	$4,075.00
	Premium on bond Payable Dr	$925.00
	To Cash		$5,000.00
	(To record semiannual interest payment and Premium Amortization)

4	Interest Expense Dr	$4,038.00
	Premium on bond Payable Dr	$962.00
	To Cash		$5,000.00
	(To record semiannual interest payment and Premium Amortization)

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