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In: Accounting

On January 1, a business issues $500,000 face value, 10 year, 10% contract rate bonds dated...

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%.

Solutions

Expert Solution

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.

ekkarill92 answered 2 years ago
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