Question

On January 1, 2018, King Co. issued 10% bonds dated January 1, 2018, with a face amount of $19.2 million. The bonds mature in 2027 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and 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. Round your intermediate calculations to the nearest whole dollar.)

Required:

1. Determine the price of the bonds at January 1, 2018.

2. Prepare the journal entry to record the bond issuance by King Co. on January 1, 2018.

3. Prepare the journal entry to record interest on June 30, 2018, using the effective interest method.

4. Prepare the journal entry to record interest on December 31, 2018, using the effective interest method.

Answer 1

1. The price of the bonds at January 1, 2018 is as follows:

Price of the bonds would be $16.99 million.

• Price of the bond is nothing but the Present value of the interest payments in addition to the present value of the maturity amount. The discounting factor is the market rate of Interest (12%) semiannually i.e., 6% per installment.
• By applying the above formula, the price of Bonds is arrived at $16,997,775.
• The discount is $2,202,225.
• Interest Amount per installment is calculated by multiplying the face value with the interest rate semiannually (5%).
• Present Value of Interest is calculated by using the annuity factor of 6% for 20 installments i.e., 11.4699.
• Present Value of Face value of $19,200,000 is arrived by multiplying it with the Present Value factor of 6% for the 20^th installment i.e., 0.3118.
• Price of the Bond (Present Value of Bond) = Present Value of Interest Payments + Present Value of Face Value at 20^th Installment.
• Discount on Issue of Bond = Face Value of the Bond - Price of the Bond.

Therefore, price of the bonds issued is $16,997,775.

2. The journal entry to record the bond issuance on Jan. 1, 2018 is as follows:

As cash is received, cash is debited for the portion of price of the bonds.

Discount expenditure is debited to discount on issue of bonds, which is to be amortized over the life of the bonds.

The entire face value of Bonds is to be credited to Bonds Payable.

3. Journal entry to record interest on June 30, 2018, using effective interest method:

Interest expense is the actual expense to the company, it is to be calculated at market rate of yield, i.e., 12%. Since Interest is paid on semiannual basis, Interest expense is calculated at 6% on carrying value (in this case price of the bonds) $16,997,775, which arrived at $1,019,866.50.

Cash payment would be restricted to the interest rate of the Bond i.e., 10%, and 5% semiannually. Cash payment would be calculated as ($19.2 million x 5% = $0.96)

The remaining amount between the interest expense and the payment of interest is the amortization portion of the discount, hence setoff by crediting the discount on issue of bonds account.

4. Journal entry to record interest on December 31, 2018, using the effective interest method:

Interest expense is the actual expense to the company, it is to be calculated at market rate of yield, i.e., 12%. Since Interest is paid on semiannual basis, Interest expense is calculated at 6% on carrying value $17,057,641.50, which arrived at $1,023,458.59.

Carrying value of the bonds is calculated as: [Face value of Bonds - Unamortized Discount on Issue of Bonds]

= $19,200,000 - ($2,202,225 - $59,866.50) = $17,057,641.50

Cash payment would be restricted to the interest rate of the Bond i.e., 10%, and 5% semiannually. Cash payment would be calculated as ($19.2 million x 5% = $0.96)

The remaining amount between the interest expense and the payment of interest is the amortization portion of the discount, hence setoff by crediting the discount on issue of bonds account.

Hope this is helpful!!