Question

On 01-01-15, B issued $800,000 of 4%, 5-year term bonds. The bonds pay interest every July 1 and January 1. At the time B issued the bonds, similar bonds paid 4.5%. Upon issuing the bonds, B incurred and paid $7,500 of bond issuance costs. B uses the effective-interest method to amortize any bond discount or premium. B only prepares AJEs every December 31. Prepare the entries B should make on:

a. 01-01-15

b. 07-01-15

c. 12-31-15

d. 01-01-16

Answer 1

Solution:

It is given in the question that similar bonds paid 4.5% interest rate. It means the market interest rate is 4.5% and B issued the bonds at 4%. So, we need to calculate the Present Value i.e. Issue Proceeds for Cash at market interest rate 4.5%.

Par Value = $800,000

Semi Annual Coupon Interest = Par Value x Coupon Rate = 800,000*4%*1/2 = $16,000

Semiannual period to maturity = 5 years x 2 = 10

Semiannual market interest rate = 4.5%/2 = 2.25%

Present Value of Bonds = Semi Annual Coupon Interest x PVIFA (R,n) + Par Value x PVIF (R,n)

= (16,000*8.86622) + (800,000*0.80051)

= 141,860 + 640,408

= 782,268

Cash Proceeds = Present Value of Bonds Payable at market interest rate 2.25% = $782,268

Note -- Calculation of Present Value Factor

PVIFA (R, n) = Present Value interest factor for ordinary annuity at R% for n periods = (1 – 1/(1+R)ⁿ) / R

PVIFA (2.25%,10) = (1 – 1/(1+0.0225)¹⁰) / 0.0225 = 8.86622

PVIF (R, n) = Present Value interest factor for ‘n’ period at ‘R’% = 1/(1+R)ⁿ

PVIF (2.25%, 10) = 1/(1+0.0225)¹⁰= 0.800510

Cash Proceeds Received i.e. Issue Price = $782,268

Here, Issue Price is less than Par Value, it means bonds are issued at Discount.

Discount on Bonds Payable = Par Value 800,000 – Issue Price 782,268 = $17,732

Journal Entries

Date	General Journal	Debit	Credit
01-01-15 (a)	Cash (Issue Proceeds – Bond Issue Cost)	$774,768
	Bond Issue Expenses	$7,500
	Discount on Bonds Payable	$17,732
	Bonds Payable		$800,000

b) 07-01-15 --- Journal Entry on first semi annual interest payment

Company is using effective-interest method to amortize discount. So we need to prepare amortization table for rest entries.

Here is the Bond Discount Amortization Table

Schedule of Amortization of Bond Discount (Effective Rate Method)
Payment intervals	Period End	Cash Interest (Par Value of the bonds 800,000 x Coupon Rate 4%*1/2)	Interest Expenses (Book Value of Bonds x Effective Interest Rate 4.5%*1/2)	Amortization of Bond Discount (Interest Expenses - Cash Interest)	Balance of Unamortized Discount on Bonds Payable	Par Value of Bonds Payable	Book Value (Par Value - Balance of Unamortized Bond Discount)
0	1-Jan-15				$17,732	$800,000	$782,268
1	1-Jul-15	$16,000	$17,601	$1,601	$16,131	$800,000	$783,869
2	31-Dec-15	$16,000	$17,637	$1,637	$14,494	$800,000	$785,506
3	1-Jan-16	$16,000	$17,674	$1,674	$12,820	$800,000	$787,180

Journal Entries

Date	General Journal	Debit	Credit
b. 07-01-15	Interest Expense	$17,601
	Cash Interest		$16,000
	Discount on Bonds Payable		$1,601
c. 12-31-15	Interest Expense	$17,637
	Interest Payable		$16,000
	Discount on Bonds Payable		$1,637
d. 01-01-16	Interest Payable	$16,000
	Cash		$16,000

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