Question

Entries for Issuing Bonds and Amortizing Premium by Straight-Line Method

Daan Corporation wholesales repair products to equipment manufacturers. On April 1, 2016, Daan Corporation issued $3,900,000 of 8-year, 7% bonds at a market (effective) interest rate of 5%, receiving cash of $4,409,147. Interest is payable semiannually on April 1 and October 1.

a. Journalize the entry to record the issuance of bonds on April 1, 2016. For a compound transaction, if an amount box does not require an entry, leave it blank.

b. Journalize the entry to record the first interest payment on October 1, 2016, and amortization of bond premium for six months, using the straight-line method. The bond premium amortization is combined with the semiannual interest payment. (Round to the nearest dollar.) For a compound transaction, if an amount box does not require an entry, leave it blank.

c. Why was the company able issue the bonds for $4,409,147 rather than for the face amount of $3,900,000?

The market rate of interest is the contract rate of interest.

Answer 1

a) cash a/c Dr. $4409147

To bonds payable $3900000

To premium on bonds payable $509147

b) cash payment = $3900000*7%*1/2 = $136500

For each interest payment, Cash will decrease or be credited $136500

to calculate the amount of bond premium to be amortized. Since the company uses straight-line amortization, we will record the same amount of amortization each time interest is paid. On a 8-year semiannual bond, there will be 16 payments.

$509147/16= 31821.68

Each time an interest payment is recorded, we will amortize $31821.68 of premium. The normal balance in Premium on Bonds Payable is a credit. Therefore, in order to amortize or reduce the amount of the account, we must debit the account.

The last step is to compute the amount of interest expense. Interest expense is $136,000 less the amount of the amortized premium. When bond purchasers pay a premium it is as though they are offsetting some of the interest. For each payment made, $31821.68 of the premium is returned to the purchasers which lowers the amount of interest expense for the company. The amount of interest expense is $104178.32

interest expense Dr. $104178.32

premium on bond payable Dr. $31821.68

To cash 136000

c)If the market interest rate is lower than the face rate, the bond will sell for more than face value. The bond will be sold for a premium.