Question

Universal foods issued 12% bonds, dated January 1, with a face amount of $155 million on January 1, 2018 to Wang Communcations. The bonds mature on December 31, 2032 (15 years). The market rate of interest for similar issues was 14%. Interest is paid semiannually on June 30 and December 31. Universal uses the straight line method. Universal Foods sold the entire bond issue to Wang Communications.

Required: 1-3. Prepare the journal entry to record the purchase of the bonds by Wang Communications on January 1, 2018, interest REVENUE on June 30, 2018 and interest REVENUE on December 31, 2025.

Answer 1

It is asked to record the journal entries in the books of the investor in bonds that is Wang Communications. In order to record any transaction, it is important to know the issue price of the bonds by Universal foods.

Issue price of the bonds can be understood from the following table:

• Face value of the bonds are $155 million which is provided to us in the question.
• The Interest rate of Bonds is 12% per annum, which is 6% semi annually.
• Price of the bond is nothing but the Present value of the interest payments in addition to the present value of the maturity amount. The discounting factor is the market rate of Interest (14%) semiannually i.e., 7% per installment.
• By applying the above formula, the price of Bonds is arrived at $135,765,986.
• The discount is $19,234,014.
• Interest Amount per installment is calculated by multiplying the face value with the interest rate semiannually (6%).
• Present Value of Interest is calculated by using the annuity factor of 7% for 30 installments i.e., 12.4090.
• Present Value of Face value of $155,000,000 is arrived by multiplying it with the Present Value factor of 7% for the 30^th installment i.e., 0.131367.
• Price of the Bond (Present Value of Bond) = Present Value of Interest Payments + Present Value of Face Value at 30^th Installment.
• Therefore, Bonds are purchased by Wang Communications at $135,765,986.
• Discount on Issue of Bond = Face Value of the Bond - Price of the Bond.

Journal entry to record the purchase of the bonds and interest REVENUE on June 30, 2018 and December 31, 2025 in the books of WANG COMMUNICATIONS are as follows:

• Purchase of bonds is recorded by debiting the bonds of Universal foods, as they are the asset to the company. Cash is credited because, cash has been paid to acquire those bonds.
• Interest is calculated on the face value of the bonds ($155,000,000) at nominal rate of 12% p.a. at 6% semiannual rate. We get $9,300,000 ($155,000,000 x 6%). Interest on Bonds is income to the company, hence Interest on Bonds is credited and as cash will be received for interest, cash is debited.
• Interest amount won't differ eventhough life of bond expires for an investor. Interest amount might change gradually for the investee as there would be amortization of discount, none of such things are applicable to investor. Hence there would be no change in the entries of interest passed on June 30, 2018 and December 31, 2025 for Wang Communications.