Question

1. Grant Inc. issued $400,000 of 6% bonds on June 30, 2016. The bonds mature in 10 years. For bonds of similar risk and maturity, the market interest rate is 4%. Interest is paid semiannually on December 31 and June 30. (i.e., the first interest payment will be made on December 31, 2016). For all computations, ignore below decimal point.

a) Determine whether the company sold the bond at discount or premium

b) Determine the price of the bonds at June 30, 2016 and prepare the journal entry to record the issuance of the bonds.

c) Prepare the journal entry to record interest on December 31, 2016 by using effective interest method

d) Prepare the journal entry to record interest on June 30, 2017 by using effective interest method

e) Grant Inc. did not hold the bond to maturity and retired the bond on July 1, 2017, at 105 (i.e., 105% of face value). Prepare the journal entry to record the extinguishment of the bonds on July 1, 2017. Ignore one-day interest between June 30 and July 1. In other words, the carrying value of the bonds as of June 30, 2017 (computed in question d) should be eliminated by the extinguishment of the bonds on July 1, 2017.

Answer 1

Solution:

Part a & b

Determine the price of the bonds issued on June 30, 2016

It is given in the question that bonds of similar risk and maturity, the market interest rate is 4%. It means the Market Rate of Return on the bonds is 4%. So we need to calculate the Price of the bonds issued by using the market yield 4%.

Primary Working

Par Value = $400,000

Semi Annual Coupon Interest = Par Value 400,000* Coupon Rate 6% * 1/2 Half Yearly = $12,000

Semiannual period to maturity (n) = 10 years x 2 = 20

Semi Annual Market Interest Rate (R) = 4%*1/2 = 2%

Present Value of Bonds (Price of the bonds issued) = Semi Annual Coupon Interest x PVIFA (R,n) + Par Value x PVIF (R,n)

= (12,000*16.35143) + (400,000*0.67297)

= $196,217 + $269,188

= $465,405

Note -- Calculation of Present Value Factor (Rounded to 5 decimal places)

PVIFA (R, n) = Present Value interest factor for ordinary annuity at R% for n periods = (1 – 1/(1+R)ⁿ) / R

PVIFA (2%,20) = (1 – 1/(1+0.02)²⁰) / 0.02 = 16.35143

PVIF (R, n) = Present Value interest factor for ‘n’ period at ‘R’% = 1/(1+R)ⁿ

PVIF (2%, 20) = 1/(1+0.02)²⁰= 0.67297

The Issue Price of the bonds = $465,405

a) Issue price of the bonds are higher than the face value of the bonds, it means the bonds are issued at premium.

b) Price of the bonds at June 30, 2016 = $465,405

Journal Entry

Date	General Journal	Debit	Credit
June.30, 2016	Cash	$465,405
	Bonds Payable		$400,000
	Premium on Bonds Payable (bal fig)		$65,405

To answer the Part c, d and e – we need to prepare an Amortization Table for Bond Premium till June 30, 2017

Schedule of Amortization of Bond PREMIUM (Effective Rate Method)
Payment intervals	Date	Cash Paid (Face Value of the Bonds $400,000 x Coupon Rate 6% * 1/2 half yearly)	Interest Expense (Carrying Value at the beginning of period x Market Interest Rate 4% * 1/2 Half Yearly)	Premium Amortization (Cash Paid - Interest Expense)	Carrying Amount of Bonds
0	June.30, 2016				$465,405
1	Dec.31, 2016	$12,000	$9,308	$2,692	$462,713
2	June.30, 2017	$12,000	$9,254	$2,746	$459,967

Part c -- journal entry to record interest on December 31, 2016 by using effective interest method

Date	General Journal	Debit	Credit
Dec.31, 2016	Interest Expense	$9,308
	Premium on Bonds Payable (Amortization)	$2,692
	Interest Payable		$12,000

Part d-- journal entry to record interest on June 30, 2017 by using effective interest method

Date	General Journal	Debit	Credit
June.30, 2017	Interest Expense	$9,254
	Premium on Bonds Payable (Amortization)	$2,746
	Interest Payable		$12,000

Part e – Extinguishment of the bonds

Carrying Value of the bonds on July 1, 2017 = $459,967

It includes unamortized premium = $59,967 and face value $400,000

Extinguishment Value of the bonds = Face Value x 105% = $400,000 * 105% = $420,000

Carrying Value is higher than Extinguishment Value, it means the company is paying less amount to extinguish the bonds. Hence company will record a gain on extinguishment of the bonds.

Date	General Journal	Debit	Credit
July.1, 2017	Bonds Payable	$400,000
	Premium on Bonds Payable (Unamortized Portion)	$59,967
	Cash (paid for extinguishment of the bonds)		$420,000
	Gain on Retirement of the bonds (Bal fig)		$39,967

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you