Question

1. Cutler Inc. issued $20 million of 8 year 10% callable bonds dated July 1, 2018. The bonds were issued at 95. The bonds are callable at 10 Burroughs uses straight-line amortization. Record the following transactions.
   1. Record the issuance on July 1.
   2. Record the first payment of interest on December 31.
   3. Record the second payment of interest on June 30.
   4. Was the effective interest rate greater than, less than, or equal to 10%?
   5. Record the bonds called on July 1, 2019.

Answer 1

                                                                                                                                                 In Millions

Date	Particulars	LF	Debit ($)	Credit($)
2018 July, 1	Bank a/c ……………………………..Dr Discount on issue of Bonds a/c 20 Million X 5% …Dr To 10% Callable bonds a/c (10% callable bonds of $ 20 million issued at a discount of 5%)		1 19	20
Dec 31	Interest on Bonds a/c ( 20 Million X 10%X 6/12)...............................Dr To Bank a/c ( Being interest at 10% for 6 months paid )		1	1
2019 June 30th	Interest on Bonds a/c ( 20 Million X 10%X 6/12).................................Dr To Bank a/c ( Being interest at 10% for 6 months paid )		1	1
June 30th	Profit and loss a/c ……………Dr To Discount on issue of Bonds a/c (As bonds are called in one-year entire discount amortized without applying staring line method of amortization)		1	1
July 1	10% Callable bonds a/c…………Dr           To Bank a/c ( being bonds called and redeemed at par)		20	20

The effective rate of interest is computed as below:

Actual rate + { Loss on issue/ duration of issue}

----------------------------------------------------------           X 100

Maturity value + Redeemable value /2

                        10 +   $5/8

                       -----------------= 10.897%

                        100+95/2

                                                                                       Hence, the effective rate is more than 10%