Question

On 1 April 2018, Shen Ltd acquired specialized equipment by issuing $2,700,000 of face value, 9% ten-year bonds to the equipment’s manufacturer. No cash changed hands. The bonds will pay interest semi-annually, beginning with the first payment due on 1 October 2018. The market interest rate on the issue date was 10%. The equipment, which was available for use immediately, will be depreciated under the declining balance method at 30%. The estimated residual value is $200,000. Ignore GST. Round to two decimal places.

Required:

1. Prepare the journal entry for equipment purchase/bond issuance on 1 April 2018.
2. Shen Ltd adjusts and closes its books annually on 31 July. Prepare Shen Ltd’s two required adjusting journal entries on that date. For depreciation purposes, you may use a cost figure of $2,500,000.
3. Prepare the journal entry for the first payment due on 1 October 2018.
4. On 1 April 2019, after the interest was paid, Shen Ltd and the equipment’s manufacturer agreed that the bonds would be redeemed at a market price of 93.

1. Prepare the journal entry to record the redemption. (Assume that Shen Ltd’s carrying value for the bonds on the redemption date was $2,542,491.)
2. At a market price of 93, was the market interest rate on the date of redemption greater than, less than, or equal to 9%? Explain your answer.

5. Assume the redemption resulted in a gain for Shen Ltd. You have been asked to help assess the immediate impact of the redemption on Shen Ltd’s return on asset ratio. In your answer, first identify the numerator and denominator of the ratio; then explain the impact, if any, on the numerator; finally, explain the impact, if any, on the denominator. Then conclude as to the overall effect.
6. Ignore d) above and assume Shen Ltd will redeem the bonds at maturity.
   1. How much interest expense will be recognised over the life of the bonds?
   2. Why isn’t the total amount of interest expense shown as a liability on 1 April 2018, given that it is highly probable that Shen Ltd will pay (relevance) and the amount can be measured without error (faithful representation)?

Answer 1

SOLUTION a
	Date	Particulars		Debit	Credit
	1-Apr-18	Equipment A/C Dr		$2,700,000.00
		To Manufacturer A/C		$2,700,000.00
		Being Equipment Purchased
	1-Apr-18	Manufacturer A/C Dr	$2,700,000.00
		To 9% Bonds A/C			$2,700,000.00
		Being 9% Bonds Issued
SOLUTION b
	Date	Particulars		Debit	Credit
	31-Jul-18	Depreciation A/C Dr	$187,500.00
		To Equipment A/C		$187,500.00
		Being Depreciation Booked
	31-Jul-18	Interest Expense A/C Dr	$60,750.00
		To Interest Accrued		$60,750.00
		Being Interest Accrued But Not Payble
	31-Jul-18	Profit And Loss A/C Dr	$248,250.00
		To Depreciation A/C		$187,500.00
		To Interest Expense A/C		$60,750.00
		Being Curent Year Expenses Being Charged To Profit And Loss A/C
SOLUTION c
	Date	Particulars		Debit	Credit
	1-Oct-18	Interest Accrued A/C Dr	$60,750.00
		Interest Expense A/C Dr	$60,750.00
		To Manufacturer A/C		$121,500.00
		Being Interest Due Entry Passed
	1-Oct-18	Manufacturer A/C Dr	$121,500.00
		To Cash /Bank A/C			$121,500.00
		Being Interest Due Paid
SOLUTION d
i	Date	Particulars		Debit	Credit
	1-Apr-19	9% Bonds A/C Dr		$2,542,491.00
		To Manufacturers A/C		$2,511,000.00
		To Profit And Loss A/C		$31,491.00
		Being 9% Bonds Bonds Redeemed At Discounted Price
	1-Apr-19	Manufacturer A/C Dr	$2,511,000.00
		To Cash / Bank			$2,511,000.00
		Being Redemption Amount Paid To Manufacturer
ii
	As Market Price Is Declined , Market Rate Of Interest Is Grater Than 9%
	As Coupon Rate Is Less Than Market Interest Rate Market Value Of Bond Is Declined