Question

Week 2 a) What factors should be considered in determining the issue price of a debenture. b) On 1 July 2018 Bombo Ltd issues $2 million in six-year debentures that pay interest each six months at a coupon rate of 8 per cent. At the time of issuing the securities, the market requires a rate of return of 6 per cent. Interest expense is determined using the effective-interest method. Required: (i) Determine the issue price of the debenture. (ii) Provide the journal entries at: 1 July 2018, 30 June 2019, & 30 June 2020.

lots of different answers can I get a proper answer please

Answer 1

Answer:

Factors to be considered in determining the issue price of debenture-

a. Company's credit rating and past track record of honoring the debt

b. Key coverage ratio's e.g. interest coverage ratio

c. Purpose for which debt to be used

d.Cash flow from operations in past

e.Security offered as collateral

f.Prevailing interest rate in the economy and benchmark rate of interest declared by central bank

2. Computation of debenture issue price-

			Inflow			Outlow
Date	PV factor (A) @ 6%	Closing outstanding= G	Principal (C)	Interest for the 6 months (Outstanding amount * 4%) (D)	Closing outstanding (C+D)= G	Principal (T)	interest (U)	total outflow (E) = (T+U)	Net cash flow (Z)= (C-Z)	Net present value (A*Z)
01-07-2018	1.00	-	20,00,000	-	20,00,000	-	-	-	20,00,000	20,00,000
31-12-2018	0.97	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-77,670
01-07-2019	0.94	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-75,408
31-12-2019	0.92	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-73,211
01-07-2020	0.89	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-71,079
31-12-2020	0.86	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-69,009
01-07-2021	0.84	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-66,999
31-12-2021	0.81	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-65,047
01-07-2022	0.79	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-63,153
31-12-2022	0.77	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-61,313
01-07-2023	0.74	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-59,528
31-12-2023	0.72	20,00,000	-	80,000	20,00,000	-	80,000	80,000	-80,000	-57,794
01-07-2024	0.70	20,00,000	-	80,000	-	20,00,000	80,000	20,80,000	-20,80,000	-14,58,870
							Net present value			-1,99,080
Note-
1	Assumed that interest is 8% compounded annually. Hence, for 6 months interest is 4%.
2	Assumed principal is payable at the time of redemption.
Conclussion	$2,000,000 debenture should be issued at a premium of $ 199,080. Hence, total amount received on issued of $2,000,000 8% debture is $2,199,080.

3. Journal entries to be recorded are as-

Date	Description	Debit ($)	Credit ($)
01-07-2018	Bank/ Cash A/c-- Dr	21,99,080
	8% Debenture liability A/c		20,00,000
	Security Premium A/c		1,99,080
	(To record 8% debentures issued at premium)
31-12-2018	Interest expenses A/c--- Dr	80,000
	Interest liability A/c		80,000
	(To record interest expenses for 6 months recorded)
	Interest liability A/c	80,000
	Bank/cash A/c		80,000
	(To record interest paid)
30-06-2019	Interest expenses A/c--- Dr	80,000
	Interest liability A/c		80,000
	(To record interest expenses for 6 months recorded)
	Interest liability A/c	80,000
	Bank/cash A/c		80,000
	(To record interest paid)
31-12-2019	Interest expenses A/c--- Dr	80,000
	Interest liability A/c		80,000
	(To record interest expenses for 6 months recorded)
	Interest liability A/c	80,000
	Bank/cash A/c		80,000
	(To record interest paid)
30-06-2020	Interest expenses A/c--- Dr	80,000
	Interest liability A/c		80,000
	(To record interest expenses for 6 months recorded)
	Interest liability A/c	80,000
	Bank/cash A/c		80,000
	(To record interest paid)

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