Question

Problem 14-5 Issuer and investor; effective interest; amortization schedule; adjusting entries [LO14-2]

On February 1, 2018, Cromley Motor Products issued 10% bonds, dated February 1, with a face amount of $60 million. The bonds mature on January 31, 2022 (4 years). The market yield for bonds of similar risk and maturity was 12%. Interest is paid semiannually on July 31 and January 31. Barnwell Industries acquired $60,000 of the bonds as a long-term investment. The fiscal years of both firms end December 31. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. Determine the price of the bonds issued on February 1, 2018.
2-a. Prepare amortization schedules that indicate Cromley’s effective interest expense for each interest period during the term to maturity.
2-b. Prepare amortization schedules that indicate Barnwell’s effective interest revenue for each interest period during the term to maturity.
3. Prepare the journal entries to record the issuance of the bonds by Cromley and Barnwell’s investment on February 1, 2018.
4. Prepare the journal entries by both firms to record all subsequent events related to the bonds through January 31, 2020.

Answer 1

Requirement(1):Determine the price of the bonds issued on February 1, 2018:

Cash interest paid: 10% x $60,000,000 x 6/12 = $3,000,000

Present value of interest: Table , 8 payments @ 6% = 6.20979 x $3,000,000 = $18,629,370

Present value of $80 million: Table , 8 periods @ 6% = 0.62741x $60,000,000 = $37,644,600

Price of bonds: $56,273,970 ($18,629,370+ $37,644,600)

Barnwell purchased 60,000 ÷ 60,000,000 = 0.1% of the bonds.

Therefore, the price paid was 0.1% x $56,273,970 = $56,274

Requirement(2):Preparation of amortization schedules that indicates (a) Cromley’s effective interest expense and (b) Barnwell’s effective interest revenue for each interest period during the term to maturity:

   Barnwell’s

Payment Number	Cash Payment	Effective Interest	Discount Amortized	Balance
				56,274
1	3,000	3,376	376	56,650
2	3,000	3,399	399	57,049
3	3,000	3,423	423	57,472
4	3,000	3,448	448	57,921
5	3,000	3,475	475	58,396
6	3,000	3,504	504	58,900
7	3,000	3,534	534	59,434
8	3,000	3,566	566	60,000

  

Payment Number	Cash Payment	Cromley’s Effective Interest	Discount Amortized	Balance
				562,73,970
1	30,00,000	33,76,438	3,76,438	566,50,408
2	30,00,000	33,99,024	3,99,024	570,49,433
3	30,00,000	34,22,966	4,22,966	574,72,399
4	30,00,000	34,48,344	4,48,344	579,20,743
5	30,00,000	34,75,245	4,75,245	583,95,987
6	30,00,000	35,03,759	5,03,759	588,99,746
7	30,00,000	35,33,985	5,33,985	594,33,731
8	30,00,000	35,66,269	5,66,269	600,00,000

Requirement(3):Prepare the journal entries to record (a) the issuance of the bonds by Cromley and (b) Barnwell’s investment on February 1, 2018.

Cromley:

Cash                                                     56,273,970

Discount on B/P                                   3,726,030

        Bonds Payable                                                 60,000,000

Barnwell:

Investment in Bonds                                                                  60,000

           Discount on bond investment                                                             3,726

           Cash                                                                                                        56,274

Requirement(4):Prepare the journal entries by both firms to record all subsequent events related to the bonds through January 31, 2020.

Cromley

Date	Particulars	Debit	Credit
31/07/2018	Interest Expense               Discount on B/P               Cash	33,76,438	3,76,438 30,00,000
31/12/2018	Interest Expense (33,99,024*5/6)               Discount on B/P (3,99,024*5/6)              Interest Payable (30,00,000*5/6)	28,32,520	3,32,520 25,00,000
31/01/2019	Interest Expense(33,99,024*1/6) Interest Payable               Discount on B/P (3,99,024*1/6)               Cash	5,66,504 25,00,000	66,504 30,00,000
31/07/2019	Interest Expense               Discount on B/P               Cash	34,22,966	4,22,966 30,00,000
31/12/2019	Interest Expense (34,48,344*5/6)               Discount on B/P (4,48,344*5/6)              Interest Payable (30,00,000*5/6)	28,73,620	3,73,620 25,00,000
31/01/2020	Interest Expense(34,48,344*1/6) Interest Payable               Discount on B/P (4,48,344*1/6)               Cash	5,74,724 25,00,000	74,724 30,00,000

Barnwell

Date	Particulars	Debit	Credit
31/07/2018	Cash Disc on Bond Invest              Interest Revenue	3,000    376	3,376
31/12/2018	Interest Receivable (3,000 x 5/6) Disc on Bond Invest (399 x 5/6)                Interest Revenue (3,399 x 5/6)	2,500     332.5	2835.5
31/01/2019	Cash Disc on Bond Invest (399 x 1/6)                     Interest Receivable                     Interest Revenue (3,399 x 1/6)	3,000        66.5	2,500     566.5
31/07/2019	Cash Disc on Bond Invest              Interest Revenue	3,000    423	3,423
31/12/2019	Interest Receivable (3,000 x 5/6) Disc on Bond Invest (448 x 5/6)                Interest Revenue (3,448 x 5/6)	2,500     373.33	2873.33
31/01/2020	Cash Disc on Bond Invest (448 x 1/6)                     Interest Receivable                     Interest Revenue (3,448 x 1/6)	3,000        74.67	2,500     574.67