Question

Can anyone explain to me how I solve this, I need to prepare a journal entry for the given problem:

on jan 1 a corporation issued $325,000, 5.5%, 9 year bonds when the market rate was 6%. Interest is to be paid annually on each Jan 1

Answer 1

Here, the coupon rate = 5.5 %

Market rate = 6 %

When the coupon rate is lower than the market rate , then bonds are issued at discount . Because if the investors invest the same amount ( face amount of bonds ) in other market investment options they can get higher return than bonds interest .

Step 1) To calculate the present value of principal amount :

PV of Principal = Face amount / ( 1 + market rate )^{time period}

PV of Principal = $ 325,000 / ( 1 + 0.06)⁹

PV of Principal = $ 325,000 / 1.689479

PV of Principal = $ 192,367

Step 2 ) To calculate present value of interest

Annual interest on bonds = $ 325,000 X 5.5% = $ 17,875

PV of interest = Annul interest X [ 1 - { 1/(1+ market rate )^{time period} }] / market rate

PV of interest = $ 17,875 X [ 1 - { 1/(1+ 0.06)⁹}] /0.06

PV of interest = $ 17,875 X [ 1 - {1/1.689479}] / 0.06

PV of interest = $ 17,875 X [ 0.689479/1.689479] / 0.06

PV of interest = $ 17,875 X 0.40810155 / 0.06

PV of interest = $ 17875 X 6.8016925

PV of interest = $ 121,580.25 or $ 121,580

Step 3)  Net Proceed from issuance of bonds = PV of principal + PV of interest

Net proceed from issuance of bonds = $ 192,367 + $ 121,580 = $ 313,947

Discount on bonds payable = Face amount of bonds payable - Sales proceed from issuance of bonds

Discount on bonds payable = $ 325,000 - $ 313,947 = $ 11,053

Step 4 )  Journal Entry

Date	Accounts title and explanation	Debit	Credit
January 1	Cash	313,947
	Discount on bonds payable	11,053
	Bonds Payable		325,000
	[Bonds issued at a discount ]

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