Question

a) What factors should be considered in determining the issue price of a debenture.

b) On 1 July 2018 Bombo Ltd issues $2 million in six-year debentures that pay interest each six months at a coupon rate of 8 per cent. At the time of issuing the securities, the market requires a rate of return of 6 per cent. Interest expense is determined using the effective-interest method.

Required:

(i) Determine the issue price of the debenture.

(ii) Provide the journal entries at: 1 July 2018, 30 June 2019, & 30 June 2020.

Answer 1

Requirement: A

Factors to be considered before issuing debentures are:

1) Company Cash flow

2) Company`s Credit rating

3) Company profitability

4) Debenture Issue and its purpose.

5) Company`s Interest Coverage Ratio

6) Prevailing interest rate in the market

Requirement: B1

Present value of interest payments	$      796,320
[$2,000,000*4/100*9.954004 PV annuity factor (3%, 6 years, semi annual bond)]
Present value of the face value	$   1,402,760
[$2,000,000*0.70138 PV ordinary factor (3%, 6 years)]
Issue Price of Debenture	$   2,199,080

Requirement: B2

No.	Date	General Journal	Debit	Credit
1	1/7/2018	Cash	$   2,199,080
		Premium on Debenture		$      199,080
		Debentures		$ 2,000,000
		(To record bond issued at premium )
2	30/6/2019	Interest Expense	$         65,552
		Premium on Debenture	$         14,448
		Cash		$        80,000
		( To record interest expense paid)
3	30/6/2020	Interest Expense	$         64,672
		Premium on Debenture	$         15,328
		Cash		$        80,000
		( To record interest expense paid)

Working:

Schedule of Interest Expense and Debenture Premium Amortization
Effective-Interest Method
Date	Cash Paid	Interest Expense	Decrease in Carrying Value	Carrying Value
1/7/2018				$            2,199,080
12/31/2018	$         80,000	$                  65,972	$               14,028	$            2,185,052
30/6/2019	$         80,000	$                  65,552	$               14,448	$            2,170,604
12/31/2019	$         80,000	$                  65,118	$               14,882	$            2,155,722
30/6/2020	$         80,000	$                  64,672	$               15,328	$            2,140,394
12/31/2020	$         80,000	$                  64,212	$               15,788	$            2,124,606
30/6/2021	$         80,000	$                  63,738	$               16,262	$            2,108,344
12/31/2021	$         80,000	$                  63,250	$               16,750	$            2,091,594
30/6/2022	$         80,000	$                  62,748	$               17,252	$            2,074,342
12/31/2022	$         80,000	$                  62,230	$               17,770	$            2,056,572
30/6/2023	$         80,000	$                  61,697	$               18,303	$            2,038,269
12/31/2023	$         80,000	$                  61,148	$               18,852	$            2,019,417
30/6/2024	$         80,000	$                  60,583	$               19,417	$            2,000,000