Question

The Empire Company issues $3 million in bonds on January 1, Year One. The bonds are for three years with $1 million paid at the end of each year plus interest of 6 percent on the unpaid balance for that period. These bonds are sold to yield an effective rate of 8 percent per year. The present value of $1 at an 8 percent interest rate in one year is $0.92593, in two years is $0.85734, and in three years is $0.79383. The present value of an ordinary annuity of $1 at an 8 percent interest rate over three years is $2.57710.

a. What amount of cash will Empire pay on December 31 of each of these three years?

b. What is the present value of these cash payments at an 8 percent effective annual interest rate?

c. What journal entry or entries is recorded on December 31, Year One?

d. What journal entry or entries is recorded on December 31, Year Two?

Answer 1

Answer a.
Amount of Cash Paid on Dec 31:
Year	Particulars	Amount Paid
1	Interest Paid - $3,000,000 X 6%	180,000
	Bonds Paid	1,000,000
	Total Cash Paid	1,180,000
2	Interest Paid - $2,000,000 X 6%	120,000
	Bonds Paid	1,000,000
	Total Cash Paid	1,120,000
3	Interest Paid - $1,000,000 X 6%	60,000
	Bonds Paid	1,000,000
	Total Cash Paid	1,060,000
Answer b.
Amount of Present Value of Cash Paid on Dec 31:
Year	Particulars	Amount Paid	PV Factor - 8%	Present Value
1	Interest Paid - $3,000,000 X 6%	180,000	0.92593	166,667
	Bonds Paid	1,000,000	0.92593	925,930
	Total	1,180,000	0.92593	1,092,597
2	Interest Paid - $2,000,000 X 6%	120,000	0.85734	102,881
	Bonds Paid	1,000,000	0.85734	857,340
	Total	1,120,000	0.85734	960,221
3	Interest Paid - $1,000,000 X 6%	60,000	0.79383	47,630
	Bonds Paid	1,000,000	0.79383	793,830
	Total	1,060,000	0.79383	841,460
	Total PV of Cash Paid			2,894,278

Answer c & d.
Journal Entry
Date	Particulars	Dr. Amt.	Cr. Amt.
Year 1	Cash	2,894,278
	Discount on Issue of Bonds	105,722		$3,000,000 - $2,894,278
	Bonds Payable		3,000,000
	(Record the issue of Bonds)
Year 1	Interest Expenses	231,542		$2,894,278 X 8%
	Cash		180,000	$3,000,000 X 6%
	Discount on Issue of Bonds		51,542	$231,542 - $180,000
	(Record the interest paid on Bonds)
Year 1	Bonds Payable	1,000,000
	Cash		1,000,000
	(Record the Bonds Paid)
Year 2	Interest Expenses	155,666		($2,000,000 + $54,180) X 8%
	Cash		120,000	$3,000,000 X 6%
	Discount on Issue of Bonds		35,666	$155,666 - $120,0000
	(Record the interest paid on Bonds)
Year 2	Bonds Payable	1,000,000
	Cash		1,000,000
	(Record the Bonds Paid)