Question

In the 2013 third quarter, we issued $350 million aggregate principal amount of 3.4 percent Series M Notes due 2020 (the “Series M Notes”). We received net proceeds of approximately $345 million from the offering, after deducting the underwriting discount and estimated expenses. We pay interest on the Series M Notes on April 15 and October 15 of each year, commencing on April 15, 2014.

These Series M Notes are described as: Series M Notes, interest rate of 3.4%, face amount of $350, maturing October 15, 2020 (effective interest rate of 3.6%)

(a) What journal entry would have been recorded in the third quarter of 2013 to record the issuance of the Series M Notes?

(b) Record the interest payment and interest expense on April 15 and October 15, 2014. Assume the effective interest method, and record your responses to the nearest thousand dollars.

April 15:

October 15:

(c) Assume that, at the end of 2014, the prevailing market rate for interest obligations similar to these notes was 4.0%. What would be the approximate net carrying or book value of the notes at the year end? Explain.

Answer 1

Part a:
Date	Account titles and explanations	Debit ($'million)	Credit ($'million)
2013	Bank	345
	Underwriting expenses (350 -345)	5
	3.4% M series Notes		350
	(Being 3.4% M series notes issued)
	Profit and loss account	5
	Underwriting expenses (350 -345)		5
	(Being underwriting expenses charged against revenue)
Part b:
15-Apr-14	Interest expenses (350 x 3.4% x 6/12)	5.95
	Bank		5.95
	(Being interest on Notes paid)
	Profit and loss account	5.95
	Interest expenses (350 x 3.4% x 6/12)		5.95
	(Being interest expenses charged against profit and loss account)
15-Oct-14	Interest expenses (350 x 3.4% x 6/12)	5.95
	Bank		5.95
	(Being interest on Notes paid)
	Profit and loss account	5.95
	Interest expenses (350 x 3.4% x 6/12)		5.95
	(Being interest expenses charged against profit and loss account)

Part c:
Year	Annual interest and repayment	PV factors @4% pa.	Present value of annual out flow ($' millions)
2015	11.90	0.96	11.44
2016	11.90	0.92	11.00
2017	11.90	0.89	10.58
2018	11.90	0.85	10.17
2019	11.90	0.82	9.78
2020	361.90	0.79	286.01
Carrying value of Notes at the end of year 2014			338.99

The carrying value of M series notes is lower than the face value is because the obligated rate of market interest for such notes is higher than the actual rate of interest that is being paid by the organization at 3.4%.