Question

1. On January 1, 2020, North Country Co issued 10-year, 7 percent bonds with a face value of $1 million. The market rate for bonds of this class at the time of issue was 8%.   Interest is payable annually, with the first payment due on December 31, 2020.

a. Compute the issue price of the bonds.

b. Show the journal entry to record the issuance of the bonds on January 1.

c. Show the journal entry to record the first interest payment.

Answer 1

a. Calculation of issue price of the bond:

As the bond pay 7% P.A. interest on face value and the face value amount is $1,000,000. So the interest payment will be $70,000.

As the bond matures in 10 years and the market interest rate is 8% at the time of issue, the present value factor for the bond is 0.4632 . (See the table-1: "Present value of bond" below). Therefore the present value of the bond is: $463,200 (1,000,000 * 0.4632).

Likewise the present value factor for the interest payment is 6.7101 (See the table-2: "Present value of interest" below). Therefore the present value of the interest payment is: $469,707 (70,000 * 6.7101).

Now, after combining the present value of the bond and the present value of the interest payment, we get the issue price of the bond, which is: $932,907 (463,200 + 469,707).

TABLE-1: Present value of bond

TABLE-2: Present value of interest

b. Journal entry to record the issuance of the bond:

Since the issue price of the bond is lower than the face value, the bond will be issued at a discounted price. Find the entry below:

c. Journal entry to record the first interest payment:

Since the bond was issued at a discounted price, now the discount should be amortized with interest. Assuming a straight line method for amortisation , the amount of amortisation per annum will be $6,709 (67,093 / 10 years) Find the entry below: