Question

The Company sold $2,500,000 of 8 percent, five-year bonds on January 1, 2011, and would pay interest semiannually, on June 30 and December 31 of each of the five years. It sold the bonds on January 1, 2011, at 96 because the market rate of interest for similar investments was 9 percent. It decided to amortize the bond discount by using the effective interest method.

15. With regard to the bond issue on January 1, 2011, how much cash is received?

16. With regard to the bond issue on January 1, 2011, how much is bond discount?

17. With regard to the bond interest payment on December 31, 2011, how much cash is paid in interest?

18. With regard to the bond interest payment on December 31, 2011, how much is the amortization?

19. With regard to the bond interest payment on December 31, 2011, how much is interest expense?

Answer 1

15. Calculation of the cash received:-

No.of bonds issued = $ 2,500,000 / 100 = 25,000 bonds

cash received = No. of bonds * Issued price = 25,000 bonds * 96

Cash received = $ 2,400,000

16. Calculation of the bond discount :

Bond discount = no. of bonds * ( Par value - issued price ) = 25,000 bonds * ( 100 - 96 )

Bond discount = $ 100,000

17. Calculation of How much cash is paid in interest on 31st december 2011;-

cash is paid in interest on 31st december 2011 = Actual interest paid

= 2,500,000 * 8% * 6/12 = $ 100,000

cash paid in interest on 31st december 2011 = $ 100,000

18. Calculation of amortization expenses on 31st december 2011 :-

Amortization of discount on bonds payable up to 31st december 2011 using effective interest rate method :-

under effective interest rate method, interest expense is equal to market interest rate * previous book value of debt

amortization expense = interest expense - interest paid

a	b	c	d	e	f	dh
Date	Interest Expense(4.5% * Previous book value of debt I.e, in g)	interest paid (4% * face value)	amortization expense (b-c)	Balance in bond discount account	credit balance in the account bonds payable	book valueof the bonds (f-e)
jan ,1 2011	0	0	0	100,000	2,500,000	2,400,000
june 30,2011	108,000 (2,400,000 * 4.5%)	100,000 (2,500,000*4%)	8000 (108,000 - 100,000)	92,000 (100,000 -8000)	2,500,000	2,408,000
december,31,2011	108,360 (2,408,000 * 4.5%)	100,000 (2,500,000*4%)	8360	83,640 (92,000-8,360)	2,500,000	2,416,360

Amortization expense on december 31,2011 = 8,360( see in above table)

19.Calculation of interest expense on december 31,2011:-

Interest expense = interest paid amount + amortization expenses

Interest expense = 100,000 + 8,360 = $ 108,360