In: Accounting
On January 1, a business issues $500,000 face value, 10 year, 10% contract rate bonds dated January 1. Interest is payable semiannually each June 30 and December 31. Prepare any necessary journal entries on January 1 to issue the bonds under the following independent circumstances. (Please be sure to show your work.)
The market interest rate on January 1 is 10%.
The market interest rate on January 1 is 12%.
The market interest rate on January 1 is 8%.
Issue of $500,000 face value , 10 years 10% bonds.
(i) When the market rate on January 1 is 10%.
When the market rate and the coupon rate (stated rate) of interest | |||
are equal the issue price of the bond will be equal to the face value. | |||
The following entry will be recorded. | |||
Date | Account Title | Debit | Credit |
Jan.1 | Cash | 500000 | |
Bonds Payable | 500000 |
(ii) When the market rate on January 1 is 12%.
When the market rate is higher than the coupon rate (stated rate) of interest | ||||
the issue price of the bond will be less than the face value as the investors | ||||
are being offered lesser interest rate than the market. | ||||
Therefore there will be a discount on the issue of the bond. | ||||
Face value of the bond | 500000 | |||
Coupon rate | 10% | |||
Interest payment | semi- annual | |||
Semi annual interest amount (500000 x 10% /2) | 25000 | |||
Term of the bond | 6 years | |||
PV factor for $1 to be received after sixe years @12% | 0.506631121 | |||
PV factor for annuity of $1 to be received for 12 | 8.3838 | |||
periods (6 years semi annually) @6% | ||||
Present value of the face value @12% (500,000 x 0.506631) | 253316 | |||
Present value of semiannual interest (25,000 x 8.3838) | 209595 | |||
Issue price of the bond | 462911 | |||
Entry to record the issue will be | ||||
Date | Account Title | Debit | Credit | |
Jan.20 | Cash | 462911 | ||
Discount on issue of bond | 37089 | |||
Bonds Payable | 500000 | |||
The discount will be amortized over the term of the bond at each interest payment. |
(ii) When the market rate on January 1 is 8%
When the market rate is lower than the coupon rate (stated rate) of interest | ||||
the issue price of the bond will be more than the face value as the investors | ||||
are being offered higher interest rate than the market. | ||||
Therefore there will be a premuim on the issue of the bond. | ||||
Face value of the bond | 500000 | |||
Coupon rate | 10% | |||
Interest payment | semi- annual | |||
Semi annual interest amount (500000 x 10% /2) | 25000 | |||
Term of the bond | 6 years | |||
PV factor for $1 to be received after sixe years @8% | 0.630169627 | |||
PV factor for annuity of $1 to be received for 12 | 9.385 | |||
periods (6 years semi annually) @4% | ||||
Present value of the face value @8% (500,000 x 0.63017) | 315085 | |||
Present value of semiannual interest (25,000 x 9.385) | 209595 | |||
Issue price of the bond | 524680 | |||
Entry to record the issue will be | ||||
Date | Account Title | Debit | Credit | |
Jan.20 | Cash | 524680 | ||
Premium on issue of bond | 24680 | |||
Bonds Payable | 500000 | |||
The premium will be amortized over the term of the bond at each interest payment. |