Question

Spring Water Company Ltd. needed to raise $50 million of additional capital to finance the expansion of its bottled water facility. After consulting an investment banker, it decided to issue bonds. The bonds had a face value of $50 million and an annual interest rate of 4.5%, paid semi-annually on June 30 and December 31, and will reach maturity on December 31, 2026. The bonds were issued at 96.1 on January 1, 2016, for $48,050,000, which represented a yield of 5%.

Required:

a. Spring Water Company issued bonds with a face value of $50 million because it wanted to raise $50 million. However, it succeeded in raising only $48,050,000. Identify and explain two possible reasons why investors were not willing to pay $50 million for the bonds.

b. Show the journal entry to record the issuance of the bonds.

c. Show the journal entries to record the first two interest payments.

d. What amount will be reported on the statement of financial position at the end of the first year related to these bonds?

Answer 1

Solution a:

The possible reasons why investors were not willling to pay $50 million for bonds are as under:

1. The major possible reason is that market rate of interest is higher than interest offered by Spring water company due to which investors were not willing to pay $50 million for the bonds.

2. Credit profile of company is in high risk due to which investor is avoiding for investment in bond of this company. Therefore company offered discount to get the loan.

Solution b:

Journal Entries - Spring Water Company Ltd
Date	Particulars	Debit	Credit
1-Jan-16	Cash Dr	$48,050,000.00
	Discount on Bond Dr	$1,950,000.00
	To Bonds Payable		$50,000,000.00
	(Being bond having face value of $50 million issued at discount to yield 5%)

Solution c:

Journal Entries - Spring Water Company Ltd
Date	Particulars	Debit	Credit
30-Jun-16	Interest Expense Dr ($48,050,000*5%*6/12)	$1,201,250.00
	To Cash ($50,000,000*4.50%*6/12)		$1,125,000.00
	To Discount on bond		$76,250.00
	(Being interest paid and discount amortized on bond)
31-Dec-16	Interest Expense Dr ($48,126,250*5%*6/12)	$1,203,156.00
	To Cash ($50,000,000*4.50%*6/12)		$1,125,000.00
	To Discount on bond		$78,156.00
	(Being interest paid and discount amortized on bond)

Solution d:

Amount reported on statement of financial position at the end of first year related to these bonds:

Liabilities	Amount
Bond Payable	$50,000,000.00
Unamortized discount on bond	$1,795,594.00
Carrying value of bond	$48,204,406.00