Question

. The Stylist Company issued 20-year bonds on January 1. The 10% bonds have a face value of $900,000 and pay interest every January 1 and July 1. The bonds were sold for $982,808 based on the market interest rate of 9%. Stylist uses the effective interest method to amortize bond discounts and premiums. On July 1 of the first year, Stylist should record which of the following journal entries when the interest is paid. (round to the nearest dollar)

a. debit Interest Expense $45,000; credit Cash $44,226 and Discount on Bonds Payable $774.

b. debit Interest Expense $44,226 and Premium on Bonds Payable $774; credit Cash $45,000.

c. debit Interest Expense $42,930 and Premium on Bonds Payable $2,070; credit Cash $45,000.

d. debit Interest Expense $47,070; credit Cash $45,000 and Discount on Bonds Payable $2,070.

Answer 1

• All working forms part of the answer
• To answer the journal entry, please follow the following working for 1^st year amortisation

Period	Cash payment	Interest expense	Premium on Bonds payable	Carrying Value of Bond
	[A = $ 900,000 x 10% x 6/12]	[B = D x 9% x 6/12]	[C = A – B]	[D = D – C]
01-Jan (year 1)			$                              -	$                   9,82,808.00 [given]
1-Jul-(Year 1)	$                  45,000.00 [900000 x 10% x 6/12]	$            44,226.36 [982808 x 9% x 6/12]	$                   773.64	$                   9,82,034.36
1 – Jan (year 2)	$                  45,000.00 [900000 x 10% x 6/12]	$            44,191.55 [982034.36 x 9% x 6/12]	$                   808.45	$                   9,81,225.91

• Hence if you look at 1^st Jul (year 1) Row,
  Cash payment will be of $ 45,000
  Interest expense will be of $ 44,226
  Amortised premium will be of $ 774
• Hence, the correct journal entry would be: Option ‘B’:

Debit Interest expense $ 44,226
Debit Premium on Bonds Payable $ 774
Credit Cash by $ 45,000

	General Journal	Debit	Credit
1 Jul	Interest expense	$          44,226
	Premium on Bonds payable	$              774
	Cash		$                45,000