Question

Solderman Company issued $520,000​, 7%, 10-year bonds for $432,800 with a market rate of 9%. The effective interest method of amorization is used and interest is paid annually. the journal entry on the first interest payment date would include a:

A) credit to interest expense of $36400

B) credit to interest expense of $38952

C)credit to cash of $36400

D)Credit to cash of 38,952

Answer 1

Solution:

As per the information given in the question we have

Face value of the bonds = $ 520,0000 ; Book value of the bonds = $ 432,800   ;

Interest rate = $ 7 % ; Market rate = Effective Interest rate = 9 %

As per the effective interest method of amortization, the Bond discount for the first year is calculated as follows :

= ( Book value of the bonds * Effective Interest rate ) - ( Face value of the bonds * Interest rate )

= ( $ 432,800 * 9 % ) - ( $ 520,000 * 7 % )

= $ 38,952 - $ 36,400

= $ 2,552

Thus the amount to be credited to Discount on Bonds payable a/c is = $ 2,552

The total Interest amount payable in cash is = ( Face value of the bonds * Interest rate )

= ( $ 520,000 * 9 % )

= $ 36,400

Thus the amount to be credited to Cash a/c is = $ 36,400

The amount of Interest debited to Interest Expense account = Total Interest amount payable in cash + Bond discount

= $ 36,400 + $ 2,552

= $ 38,952

Thus the amount to be debited to Interest Expense a/c is = $ 38,952

Thus the Journal entry on the first payment date is

Particulars	Debit Amount	Credit Amount
Interest Expense    a/c   Dr.	$ 38,952
To Discount Payable on bonds a/c		$ 2,552
To Cash a/c		$ 36,400

Thus the journal entry on the first interest payment date would include a:

C) Credit to cash of $ 36,400

The solution is Option C)

Note :

The other options are incorrect due to the following reasons

A) credit to interest expense of $ 36,400

The total Interest expense is the amount payable on the face value of the bonds and the amortization amount of discount on bonds

= $ 36,400 + $ 2552 = $ 38,952

The Interest expense account being an Expense account will be debited with $ 38,952.

There will be no credit to the Interest Expense a/c.

Hence, Option A is incorrect

B) credit to interest expense of $38,952

The Interest expense account being an Expense account will be debited with $ 38,952.

There will be no credit to the Interest Expense a/c.

Hence, Option B is incorrect

D)Credit to cash of $ 38,952

The amount of Interest expense payable as cash =$ 36,400

Thus the amount to be credited to cash a/c = $ 36,400 and not $ 38,952

Hence, Option D is incorrect