Question

1. Starlight Corporation issued a 8% $1,000,000 bond on January 1, 2014. The bond matures on January 1, 2019. Interest on the bond is payable semi-annually on July 1 and January 1 of each year. From the sale of the bond, the company received proceeds of $922,779. The required effective interest rate on the bond was 10%.

Instructions

(a) Calculate the discount on the bond.

(b) Prepare a bond amortization schedule for the 5 years. Be sure to clearly show the semiannual interest payments.

(c) Prepare the necessary journal entries to show:

   i. The issuance of the bond on January 1, 2014 ACCT 2015 – INTERMEDIATE FINANCIAL ACCOUNTING 11– Course Information. Academic Year 2017/2018, Semester 2 Page 24 of 41

ii. Interest payments on July 1, 2014

   iii. Interest payments on December 31, 2014

(d) Recently, the FASB and the IASB allowed companies the option of recognizing in their financial statements the fair values of their long-term debt. However, some users of the financial statements have become critical of the fair value option for financial liabilities. Describe the controversy of applying the fair value option to financial liabilities and discuss any implications it may have to the ‘faithful representation’ of financial information.

Answer 1

a.

Face Value of the bond = $1,000,000

Proceeds of the bond = $922,779

Discount on the bond = $ 77,221   

b.

Date	Cash	Interest	Discount	Balance of	Book Value	Face Value
	Payment	Expense	amortized	discount
1/1/2014				77221	922779	1000000
7/1/2014	40000	46139	6139	71082	928918	1000000
12/31/2014	40000	46446	6446	64636	935364	1000000
7/1/2015	40000	46768	6768	57868	942132	1000000
12/31/2015	40000	47107	7107	50761	949239	1000000
7/1/2016	40000	47462	7462	43299	956701	1000000
12/31/2016	40000	47835	7835	35464	964536	1000000
7/1/2017	40000	48227	8227	27238	972762	1000000
12/31/2017	40000	48638	8638	18599	981401	1000000
7/1/2018	40000	49070	9070	9529	990471	1000000
12/31/2018	40000	49530	9530	0	1000000	1000000

c.

1. To record issuance of bond
Date	Account Title	Debit	Credit
1/1/2014	Cash	922779
	Discount on bond	77221
	Bond payable		1000000
1. To record interest payment on July 1, 2014
Date	Account Title	Debit	Credit
7/1/2014	Interest Expense	46139
	Discount on bond	6139
	Cash		40000
3. To record interest payment on December 31, 2014
Date	Account Title	Debit	Credit
12/31/2014	Interest Expense	46139
	Discount on bond	6139
	Cash		40000