In: Accounting
Texxon Corporation issued $200,000 of 10-year bonds with a payment rate of 6%; payments are made semiannually. Assume that the market interest rate for similar investments is 4%, compounded semiannually.
5. What is the carrying value of the bonds after the first semi-annual interest payment date (i.e., what amount of debt will be left)?
a. $231,360.12
b. $198.423.88
c. $234,768.90
d. $196,792.36
6. The journal entry that would be made to record the issue of these bonds would include:
a. a debit to Cash for $134,600
b. a credit to Bonds Payable for $200,000
c. a credit to Premium on Bonds Payable for $98,106
d. a credit to Cash for $232,706
7. The journal entry that would be made when the first payment is made to the bondholders would include:
a. a debit to Premium on Bonds Payable for $6,000
b. a debit to Cash for $4,000
c. a debit to Interest Expense for $4,654.12
d. a debit to Discount on Bonds Payable for $1,345.88
8. The journal entry that would be made when the final payment of $200,000 is made to the bondholders would include:
a. debit Interest Expense for $4,000
b. debit Bonds Payable for $200,000
c. credit Cash for $232,706
d. debit Premium on Bonds Payable for $32,706
5. Option (a) is correct
First we will calculate the price of the bond as below:
Price of the bond can be calculated by the following formula:
Bond price = Present value of interest payment + Present value of bond payment at maturity
Semi annual bond interest = 6% * $200000 * 1/2 = $6000
Bond interest payments will be semi annual every year, so it is an annuity. Bond payment at maturity is a one time payment. The interest rate that will be used in calculating the required present values will be the semi annual market rate, which is 4% /2 = 2%, with 10*2 = 20 periods.
Now,
First we will calculate the present value of interest payments:
For calculating the present value, we will use the following formula:
PVA = P * (1 - (1 + r)-n / r)
where, PVA = Present value of annuity, P is the periodical amount = $6000, r is the rate of interest = 2% and n is the time period = 20
Now, putting these values in the above formula, we get,
PVA = $6000 * (1 - (1 + 2%)-30 / 2%)
PVA = $6000 * (1 - ( 1+ 0.02)-20 / 0.02)
PVA = $6000 * (1 - ( 1.02)-20 / 0.02)
PVA = $6000 * ((1 - 0.6729713331) / 0.02)
PVA = $6000 * (0.32702866689 / 0.02)
PVA = $6000 * 16.3514333446
PVA = $98108.6
Next, we will calculate the present value of bond payment at maturity:
For calculating present value, we will use the following formula:
FV = PV * (1 + r%)n
where, FV = Future value = $200000, PV = Present value, r = rate of interest = 2%, n= time period = 20
now, putting theses values in the above equation, we get,
$200000 = PV * (1 + 2%)20
$200000 = PV * (1 + 0.02)20
$200000 = PV * (1.02)20
$200000 = PV * 1.48594739598
PV = $200000 / 1.48594739598
PV = $134594.266622
Now,
Bond price = Present value of interest payment + Present value of bond payment at maturity
Bond price = $98108.6 + $134594.266622 = $232703
Now,
Under effective interest method, interest expense is calculated based upon market rate or yield. Here, market rate is 4%, so semi annual rate is 2%. Now,
Interest expense under effective interest method is:
Interest expense = Carrying value at the beginning of the period * Yield
Interest expense = $232703 * 2% = $4654.06
Amortization of bond premium = Interest payment - Interest expense
Amortization of bond premium = $6000 - $4654.06 = $1345.94
End of period net carrying value = $232703 - $1345.94 = $231357.06 approx.
6. Option (b) is correct
Required journal entry is:
Debit Cash $232703
Credit Bonds payable $200000
Credit Premium on bonds payable $32703
7. Option (c) is correct
Required journal entry is:
Debit Interest expense $4654.06
Debit Premium on bonds payable $1345.94
Credit Cash $6000
8. Option (b) is correct
Required journal entry is:
Debit Bonds payable $200000
Credit Cash $200000