Question

On January 1, 2021, NFB Visual Aids issued $900,000 of its 20-year, 10% bonds. The bonds were priced to yield 12%. Interest is payable semiannually on June 30 and December 31. NFB Visual Aids records interest expense at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2021, the fair value of the bonds was $768,000 as determined by their market value in the over-the-counter market. General (risk-free) interest rates did not change during 2021. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:

1-a. Determine the price of the bonds at January 1, 2021.
1-b to 4. Prepare the necessary Journal entries. ( Record the issuance of the bond, record the first interest payment, record the second interest payment, and record the entry to adjust the bond their fair value for presentation in the December 31, 2021 balance sheet.)

Answer 1

Solution:

1-a

Determination of price of the bond at 1st Jan 2021

Given Coupon Rate = 10% per annum

Interest is to be paid semiannually coupon rate = 10% / 2 = 5%

Given Yield (market rate) = 12% per annum

paid semiannually Yield rate = 12% / 2 = 6%

Life of bond = 20 years as interest is paid semiannually effective life of bond = 20*2 = 40 periods

summarising:

Coupon rate 5%

Yield rate 6%

Life of bond 40Periods

Face value of bond $900,000

Particulars	Amount ($)	Calculations
Present value of the bond @ 6% For 40 periiods	87,480	(900000)*(1/1.06)^40 =900000*0.0972
Interest @5%	677,084	900000* 5% * pvaf(6%,40periods) =45000*15.0463 =677,084
Issue price of the bond	764,564

Issue price of the bond on 1st jan 2021 = $764,564

1-b) Journal Entries

For recording issue of bonds

Particulars	Debit ($)	Credit ($)
Cash a/c	764,564
Discount on bonds payable	135,436
To Bonds Payable		900,000
(being issue of bonds on jan 1,2021 recorded)

For recording Interest expense on 30th June 2021

Particulars	Debit ($)	Credit ($)
Interest expense	45,874
To Discount on bonds		874
To cash		45,000
(being Interest expense on 30th June 2021 recorded)

For recording Interest expense on 31st December 2021

Particulars	Debit ($)	Credit ($)
Interest expense	45,926
To Discount on bonds		926
To cash		45,000
(being Interest expense on 31st Dec 2021 recorded)

For interest and Discount on bonds Calcuations:

Year	Interest Payment @ 5% on $900,000(face value)	Effective Interest (6% on Carrying Value)	Discount amortized	Carrying Value
1/1/2021				764,564
30/6/2021	45,000	45,874	874	765,438
31/12/2021	45,000	45,926	926	766,364

Fair value adjustment

Description	Amount($)
Fair Value of the Bonds	768,000
Less: Book value of the Bond
Issue price	764,564
Discount on bonds on 30th july	874
Discount on bonds on 31st Dec	926
Fair value adjustment	1,636

Fair value adjustment entry on 31st december:

Particulars	Debit ($)	Credit ($)
Unrealised loss	1,636
To Fair value adjustment		1,636

As fair market value is more than book value liability increases