Question

a. Assume a $100,000, two-year, 10% bond that makes semiannual interest payments is sold for $96,535 when the market interest rate is 12%. Prepare an amortization table and make the journal entries to record the first two interest payments. b. Assume a $250,000, three-year, 12% bond that makes semiannual interest payments is sold for $262,689 when the market interest rate is 10%. Prepare an amortization table and make the journal entries to record the first two interest payments.

Answer 1

Answer.A. THERE ARE TWO METHODS OF AMORTIZATION OF DISCOUNT ON BOND:

1. STRAIGHT- LINE METHOD

2. EFFECTIVE INTEREST RATE METHOD

WHEN STRAIGHT-LINE METHOD IS USED:

UNDER THIS METHOD BOND DISCOUNT AMORTIZED IN EACH PERIOD WILL EQUAL TOTAL BOND DISCOUNT DIVIDED BY TOTAL NO. OF PERIOD.

DISCOUNT AMOUNT = $3,465

TOTAL PERIOD = 4 ( 2 YEARS WITH SEMI ANNUALIIY TYPE)

BOND DISCOUNTED = 3465 / 4 = 866 PER SEMI ANNUALLY PERIOD

AMORTIZATION TABLE USING STRAIGHT LINE METHOD:

PERIOD	INTEREST PAYMENT(IP)	BOND DISCOUNT AMORTIZATION(BD)	INTEREST EXPENSES(IP+BD)	BALANCE IN BOND AMORTIZATION	BOOK VALUE
0	-	-	-	3465	96535
1	$ 5,000	$ 866	=5,000+866=$ 5,866	=3465-866 = 2599	=96535+866=97401
2	$ 5,000	$ 866	$ 5866	=2599-866=1733	=97401+866=98267
3	$ 5,000	$ 866	$ 5866	=1733-866=867	=98267+866=99133
4	$ 5,000	$ 866	$ 5866	=867-866=1	=99133+866=99999 OR 1,00,000

JOURNAL FOR FIRST TWO INTEREST PAYMENT USING STRAIGHT LINE METHOD:

Particulars	Debit	credit
Interest expense	$ 5,866
Amortization of discount		$ 866
cash		$ 5,000
-	-	-
Interest expense	$ 5,866
Amortization of discount		$ 866
cash		$ 5,000

WHEN USING EFFECTIVE INTEREST RATE METHOD:

= BOND AMORTIZATION = BOOK VALUE * MARKET INTEREST RATE / 2 - FACE VALUE * COUPON RATE / 2

=96535 * 12% /2 - 100000 * 10%/2 = 5792 - 5000 = 792

IN 2 ND PERIOD = BOOK VALUE WILL BE = 96535 + 792 = 97327

AMORTIZATION TABLE USING EFFECTIVE INTEREST RATE METHOD:

PERIOD	BALANCE IN BOND AMORTIZATION	BOND DISCOUNT AMORTIZATION(BD)	INTEREST PAYMENT	INTEREST EXPENSES	BOOK VALUE
0	3465	-	-		96535
1	=3465-792=2673	$ 792	$ 5,000	=5792	=96535+792=97327
2	$ 2673-839=1834	$ 839	$ 5,000	=5839	=97327+839=98166
3	$ 1834-890=944	$ 890	$ 5,000	=5890	=98166+890 = 99056
4	$944-944=0	$ 944	$ 5,000	=5944	$ 99056+944 = 100,000

JOURNAL ENTRY USING EFFECTIVE INTEREST RATE METHOD:

Particulars	Debit	credit
Interest expense	$ 5,792	-
Amortization of discount	-	$ 792
cash	-	$ 5,000
-	-	-
Interest expense	$ 5,839	-
Amortization of discount	-	$ 839
cash	-	$ 5,000

ANSWER B . PREMIUM AMORTIZATION USING STRAIGHT LINE METHOD

PREMIUM ON ISSUANCE OF BOND= $ 12689

TOTAL PERIOD = 6 ( 3 YEARS WITH SEMI ANNUALIIY TYPE)

BOND PREMIUM AMORTIZATION = 12689 / 6 = 2115 PER SEMI ANNUALLY PERIOD

AMORTIZATION TABLE USING STRAIGHT LINE METHOD:

PERIOD	INTEREST PAYMENT(IP)	BOND PREMIUM AMORTIZATION(BP)	INTEREST EXPENSES(IP-BP)	BALANCE IN BOND AMORTIZATION	BOOK VALUE
0	-	-	-	12689	262,689
1	$ 15,000	$ 2115	=15,000- 2115 = 12,885	= 12689-2115=10574	=262,689-2115=260574
2	$ 15,000	$ 2115	$ 12,885	=10574-2115=8459	=260574-2115=258459
3	$ 15,000	$ 2115	$ 12,885	=8459-2115=6344	=258459-2115=256344
4	$ 15,000	$ 2115	$ 12,885	=6344-2115=4229	=256344-2115=254229
5	$ 15,000	$ 2115	$ 12,885	=4229-2115=2114	=254229-2115=252114
6	$ 15,000	$ 2115	$ 12,885	=2114-2115=-1	=252114-2115=249999 OR 250000

JORNAL USING STRAIGHT LINE METHOD

Particulars	Debit	credit
Interest expense	$ 12,885	-
Amortization of Premium	$ 2,115	-
cash	-	$ 15,000
-	-	-
Interest expense	$ 12,885	-
Amortization of Premium	$ 2,115	-
cash	-	$ 15,000