Question

. Keller Corporation offers to issue zero-coupon bonds of $80,000 on January 1, Year One. The bonds will come due on December 31, Year Three. Keller and several potential creditors negotiate an annual interest rate of 7 percent on the bonds. The present value of $1 in 3 periods at an annual interest rate of 7 percent is $0.81630. The present value of an ordinary annuity of $1 for 3 periods at an annual interest rate of 7 percent is $2.62432. The present value of an annuity due of $1 for 3 periods at an annual interest rate of 7 percent is $2.80802.

a. Determine the amount the creditors will pay on January 1, Year One, for these bonds.

b. Record the issuance of the bonds on January 1, Year One.

c. Make the necessary adjusting entry at the end of Year One. What is the liability balance at the end of Year One?

d. Make the necessary adjusting entry at the end of Year Two. What is the liability balance at the

end of Year Two?

Answer 1

a.

Value of zero-coupon bonds = $80,000

Time to maturity = 3 years

Present value of $1 in 3 years @ 7% annual interest rate = 0.81630

Present value of $80,000 = 80,000 * 0.81630 = 65,304

So, the amount creditors will pay on January 1 of Year One = $65,304

b.

Keller Corporation will get 65,304 now which is a debit and bond payable is a credit. Hence the issuance entry record is :

Cash 65,304

Bonds Payable 65,304

c.

Annual interest rate = 7%

Interest to be recognised on bonds at the end of Year One = 7% * 65,304 = $4,571.28

Since there is no cash being paid out by Keller Corporation, bond payable will be credited in the entry as follows:

Interest expense 4,571.28

Bond payable 4,571.28

Liability balances at the end of year One:

Interest expense = $4,571.28 (to be shown in Income Statement)

Bond payable = 65,304 + 4,571.28 = $69,875.28 (to be shown in Balance Sheet)

d.

Annual interest rate = 7%

Interest to be recognised on bonds at the end of Year Two = 7% * 69,875.28 = $4,891.27

Since there is no cash being paid out by Keller Corporation, bond payable will be credited in the entry as follows:

Interest expense 4,891.27

Bond payable 4,891.27

Liability balances at the end of year Two:

Interest expense = $4,891.27 (to be shown in Income Statement)

Bond payable = 69,875.28 + 4,891.27 = $74,766.55 (to be shown in Balance Sheet)