Question

Cardinals Co issued $3,000,000 of its 10%, 12-year bonds on their authorized date of 4/1/17. The bonds were issued at a price of $2,623,494 to produce an effective yield of 12%. Interest payments are made twice per year, 4/1 and 10/1, with discounts and premiums being amortized using the effective interest method.

** REQUIRED: 1) Determine the following items: a) balance of the discount account at 4/1/18. 361242 b) amount of interest expense reported FYE 12/31/18. 316665 c) carry value of the bonds at 12/31/18. 2651496 d) total cost of borrowing over the life of the bond. 3976506 Here are the correct answers, can you please explain how they were computed.

Answer 1

Solution a:

Discount on bond issue = Face value - Issue price opf bond

= $3,000,000 - $2,623,494 = $376,506

Amortization Schedule of bond upto 1/4/2018- Effective Interest Method
Date	Cash Paid	Interest Expense	Discount Amortization	Carrying Value
01-Apr-17				$26,23,494.00
01-Oct-17	$1,50,000.00	$1,57,409.64	$7,409.64	$26,30,903.64
01-Apr-18	$1,50,000.00	$1,57,854.22	$7,854.22	$26,38,757.86

From above schedule, discount amortised upto 1-apr-2018 = 7409.64+7854.22 = $15263.86

Balance of discount at 1-april-2018 = Total discount - discount amortised = $376506 - $15263.86 = $ 361242.14

Solution b):

Amortization Schedule of bond upto 1/4/2019- Effective Interest Method
Date	Cash Paid	Interest Expense	Discount Amortization	Carrying Value
01-Apr-17				$26,23,494.00
01-Oct-17	$1,50,000.00	$1,57,409.64	$7,409.64	$26,30,903.64
01-Apr-18	$1,50,000.00	$1,57,854.22	$7,854.22	$26,38,757.86
01-Oct-18	$1,50,000.00	$1,58,325.47	$8,325.47	$26,47,083.33
01-Apr-19	$1,50,000.00	$1,58,825.00	$8,825.00	$26,55,908.33

From above schedule:

Interest expense from 1-Jan-2018 to 31-march-2018 recorded on 1-April-2018 = $157854.22 * 3/6 = $78927.11

Interest from 1-april-2018 to 30-sept-2018 recorded on 1-october-2018 = $158325.47

Accrued Interest expense from 1-october-2018 to 31-December-2018 = $158825 * 3/6 = $79412.50

Total interest expense reported FYE 12/31/2018 = $78927.11 + $158325.47 +$79412.50 = $316665.08

Solution c):

Carrying Value of bond on 1-october-2018 as per schedule in part b) = $2647083.33

Interest Expenses reported from 1-Oct-2018 to 31-Dec-2018 as calculated in b) part = $79412.50

Cash payment for actual interest due from 1-Oct-2018 to 31-Dec-2018 = $3000000* 10% * 3/12 = $75000

Discount amortised from 1-Oct-2018 to 31-Dec-2018 = $79412.50 - $75000 = $4412.50

Carrying Value of the bonds at 12/31/18 = Carrying value on 1-Oct-2018 + $4412.50 =  $2647083.33+$4412.50 = $2651496

Solution d):

Face value = $3000000

Issue Price = $ 2623494

Discount on issue of Bond = Face value - Issue price = $3000000- $2623494 = $376506

Total Interest payments = $3000000 * 10% *12 = $3600000

Total cost of Borrowing = Total interest payment + Discount on issue of bond = $3600000+ $376506 = $3976506