Question

1. On January 1, 201X, Acorn Corporation issued $600,000 of 10%, 20-year bonds for $509,580, yielding a market rate of 12%. Interest is paid on July 1 and December 31. Acorn uses the interest method to amortize the discount.

Tasks:

a. Prepare an amortization schedule for the first three semiannual periods.

b. Prepare journal entries to record the following:

Bond issue on January 1.

Semiannual interest payments on July 1 and December 31 as well as amortization of discount.

c. If the bond were issued on March 1 and interest was paid on September 1 and March 1, what would be the year-end adjusting entry on December 31, 201X, to record accrued interest and amortization of discount?

Answer 1

Part a: Amortisation table for the first three semiannual periods under Interest expense Method:

A	B	C	D	E	F	G
Date	Actual Interest	Interest expense(Market Rate X Balance in G column)	Amortisation of bond discount(C-B)	Debit balance in Bond Discount A/c	Credit balance in bonds payable A/c	Book Value of Bonds(F-E)
January 1				90420	600000	509580
July 1	30000	30575	575	89845	600000	510155
Dec31	30000	30609	609	89236	600000	510764
July 1	30000	30646	646	88590	600000	511410

Part b: Journal entries:

on issue of bond

Cash A/c Dr 509580

Discount on bonds A/c Dr 90420

To Bonds Payable A/c 600000

On Interest Payment on July 1 along with amortisation of discount

Interest Expense A/c Dr 30575

To Discount on bonds A/c 575

To Cash A/c 30000

On Interest Payment on December 31 along with amortisation of discount

Interest Expense A/c Dr 30609

To Discount on bonds A/c 609

To Cash A/c 30000

Part C: Year-end adjusting entry on December 31 to record accrued interest and amortization of discount

Interest Expense A/c Dr 20406

To Discount on Bonds 406

To Interest Accrued but not due A/c 20000

Notes:

1. Since Interest is paid semi anually the effective interest rate is 5% per Semi annual period and thats how 30000 amount is calculated.

2. The discount given on bond i.e,90420 must be amortised to interest expense over the life of the bond.

3. Effective interest rate is the market rate prevailing on the date of issue of bonds i.e, 12% which means 6% semi annually.

4. Bonds book value multiplied by effective interest rate gives the interest expense for that period.

5. For the last part of question, Interest payment is on march 1 and september 1 so the last 4 months interest(600000 X 10% X 4/12 = 20000) till december is accrued but its due date is on march 1. So the proprtionate 4 months interest of 20000 is accrued but not due. The intrest expense will also be proptionate 4 months i.e,30609/6 X 4 = 20406. Same for amortisation of discount i.e, 609/6 X 4 = 406.