Question

Assume XYZ Corp. sells $100,000 of five-year bonds with a semiannual coupon of 5%, or 10% per year. Investors think the company is risky, so they demand a 12% yield to maturity for buying these bonds.

a) What is the bond price?

b) How much is the total Discount/Premium?

c) Do all the required the journal entries (Original issuance of the bond, interest payment and the final payment)

d) Show the amortization table using both Straight line method and Effective Interest Method

Answer 1

Future value: $100,000 (The face value of the bonds).

Rate: 6% (12% yield-to-maturity divided by two semiannual periods).

Number of periods: 10 (5 years of semiannual payments).

Payment: $5,000 (5% semiannual coupon multiplied by the face value).

a) Bond price =

b) Thus, the bonds are sold at a discount of $7,360.09 ($100,000 in face value minus proceeds of $92,639.91).

c)

S.no.	Accounting Title and explanaiton	Debit	credit
	Original issue
1	Cash	92,639.91
	Discount on Bond Payable	7,360.0
	Bond Payable		100,000
2	Bond Interest Exp	5,736
	Discount on Bond Payable		736
	Cash		5,000

d)

1) Straightline Amortization method

Divide the total discount amount by 10 to get the periodic amortized discount amount.

$7,360.09 / 10 = 736

Expense will be $5000+ $736 = $5,736 every six months, for the next 5 years.

2)

Effective interest Method

To calculate the interest expense for the first period, we take the $92,639.91 carrying value of the bonds and multiply it by half the yield-to-maturity. This results in $92,639.91*(0.12/2)=$5,558.39 of interest expense for the first semiannual period.

The actual cash interest paid was only $5,000 -- the coupon multiplied by the bond's face value. However, interest expense also includes the $558.39 of amortized discount in the first six months.

To calculate interest expense for the next semiannual payment, we add the amount of amortization to the bond's carrying value and multiply the new carrying value by half the yield to maturity. Here's what the math looks like for the full five-year period.

Amortization table under Effective interest Method