Question

Question 3 On 1 January 2018, Aro Limited issued bonds with a face value of $600,000 for cash.
The bond will mature after 5 years with a stated interest rate of 8% per year. Interest is paid annually on 31 December with the first payment on 31 December 2018.
Bond investors require an effective interest rate of 9% per year.
Aro Limited accounts for the bond using the effective-interest method.
Present value of 1 at 8% for 5 years = 0.68058
Present value of 1 at 9% for 5 years = 0.64993
Present value of an ordinary annuity of 1 at 8% for 5 years = 3.99271
Present value of an ordinary annuity of 1 at 9% for 5 years = 3.88965 Required: Round to integers. a.

a. Determine the present value of the bonds on 1 January 2018.

b. Prepare the journal entry to record the issuance of bonds on 1 January 2018.

c. Prepare the bond amortisation table for Aro Limited, indicating the amount of interest payment, interest expense, amortisation, and carrying amount of the bonds at each 31 December for the first three years up to 31 December 2020.

d. Prepare the journal entry to record the first interest payment on 31 December 2018.

[Total for Question 3: 20 marks]

Answer 1

Dear Student,

If any doubts, feel free to ask

Part A

Price of bonds = present value of principal + present value of annual interest payments

Present value of principal = face value * Present value of 1 at 9% for 5 years = 600000*0.64993 = $389958

Present value of annual interest payment = annual interest * Present value of an ordinary annuity of 1 at 9% for 5 years

Annual interest = 600000*8% = $48000

Present value of annual interest payment = 48000*3.88965 = $186703

Price of bonds = 389958+186703 = $576661

Part B

Date	General journal	Debit	Credit
January 1, 2018	Cash	576661
	Discount on bonds payable (balancing figure)	23339
	Bonds payable		600000

Part C

Year	Interest payment	Interest expense (9%)	Amortization of discount	Carrying amount
January 1, 2018				576661
December 31, 2018	48000	51899	3899	580560
December 31, 2019	48000	52250	4250	584811
December 31, 2020	48000	52633	4633	589444

Interest payment = 600000*8% = $48000

Interest expense = previous carrying amount * 9%

Amortization of discount = interest expense – interest payment

Carrying amount = previous carrying amount + Amortization of discount

Part D

Date	General journal	Debit	Credit
December 31, 2018	Interest expense	51889
	Discount on bonds payable		3889
	Cash		48000