Question

cash flow effects of a bond premium

on january 1,2015 datalink Inc. issued $100,000,10%, 10nyear bonds when the market rate of interest was 8%. interest is payable on june 30 and December 31. The following financail information is available

sales $300,000

cost of sales 180,000

Gross Profit 120,000

Interest expense

Depreciation expense (14,500)

Other Expeses (82000)

Dec 31,2015 Jan. 1, 2015

Accounts Receivable 55,000 48,000

Inventory 87,000 93,000

Accounts Payable 60,000 58,000

all purchase of inventory are on account. other expenses are paid in cash

Instructions:

1.Prepare the journal entry to record the issuance of the bonds on January 1, 2015

2. Compute (a) the amount of cash paid to bondholders for interest during 2015, (b) the amount of premium amortized during 2015, assuming Datalink uses the straight- line method for the amortizing bond premiums and discounts, and (c) the amount of interest expense for 2015.

3.Prepare the cash flows from operating activities section of Data links statement of cash flows using (a) the direct method and (b) the indirect method.

Answer 1

(1).

Date	Account Titles	Debit	Credit
2015	Cash	$113590
Jan. 1	Bonds payable		$100000
	Premium on Bonds Payable		$13590
	(To record issue of bonds)

Working note;

Price of bond will be calculated as follow;

Face value is given = $100000

Interest rate (10% / 2) = 5%

Interest = $5000

Market rate (8% / 2) = 4%

Number of periods = 20

So price of bond = 5000*(1-(1.04)^-20)/.04)+100000/(1.04)^20 = $113590

Thus premium on bond ($113590 - $100000) = $13590

(2-a).

Amount of cash paid to bondholders for interest during 2015 = $10000

Working Note;

Interest paid during 2015 will be ($100000 * .05) * 2 = $10000

(2-b).

Amount of premium amortized during 2015 = $1359

Working Note;

Amount of premium amortized during 2015 will be ($13590 / 10) = $1359

(2-c).

Amount of interest expense for 2015 = $8641

Working Note;

Amount of interest expense for 2015 will be ($10000 - $1359) = $8641

(3-a).

Net income		$14859
Add:
Depreciation expense	$14500
Decrease in inventory	$6000
Increase in accounts payable	$2000	$22500
Less:
Amortization of premium	($1359)
Increase in accounts receivable	($7000)	($8359)
Net cash flow from operating activities		$29000

Working note;

Net income is calculated as follow;

($300000 - $180000 - $14500 - $82000 - $8641) = $14859

(3-b).

Collection from customers ($300000 - $7000)	$293000
Less:
Payment to suppliers ($18000 - $8000)	($172000)
Payment for other expenses	($82000)
Interest payment	($10000)
Net cash flow from operating activities	$29000