Question

On January 1, 2014, Cron Corporation issued $740,000 in bonds that mature in ten years. The bonds have a stated interest rate of 12 percent and pay interest on June 30 and December 31 each year. When the bonds were sold, the market rate of interest was 10 percent. The company uses the effective-interest amortization method. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use the appropriate factor(s) from the tables provided.)

Required:
1.	What was the issue price on January 1, 2014?

     

2.	What amount of interest expense should be recorded on (a) June 30, 2014? and (b) December 31, 2014?

     

3.	What amount of cash interest should be paid on (a) June 30, 2014? and (b) December 31, 2014?

     

4.	What is the book value of the bonds on (a) June 30, 2014? and (b) December 31, 2014?

     

Answer 1

Solution

Cron Corporation

1. Determination of the issue price on January 1, 2014:

Issue price = PV of bonds + PV of the annuity (semi-annual interest payments) over 20 periods at market rate of 5%.

PV bonds = PV $740,000 (P/F, 20, 5%)

PV of bonds = $740,000 x 0.3769 = $278,906

Semiannual interest = $740,000 x ½ x 12% = $44,400

PV of annuity of semi-annual interest payments = $44,400 (P/A, 20, 5%)

PV of annuity of semi-annual interest payments = $44,400 x 12.462 = $553, 313

Total issue price = $278,906 + $553,313 = $832,219

1. Determination of the amount of interest expense to be recorded on

1. June 30, 2014 –

Total issues price = $832,219

Less: face value = $740,000

Premium on bond = $92, 219

Using effective interest rate amortization method to amortize $92,219 over 20 periods, the Interest Expense for 6 months would be 5% (10% x1/2) of the carrying value of the bond.

Carrying value = $832,219

Interest Expense as on June 30, 2014 would be = $832,219 x 5% = $41,611

Interest Paid = $44,400

Premium amortized = $44,400 - $41,611 = $2,789

1. December 31, 2014 –

Premium amortization = $2,789

Reduction in Premium on bond = $92,219 - $2,789 = $89,430

Carrying value of bond = $832,219 - $2,789 = $829,430

Interest Expense as on December 31, 2014 = $829,430 x 5% = $41,472

Interest Paid = $44,400

Premium amortized = $44,400 - $41,472 = $2,928

1. Determination of the amount of cash interest to be paid on

1. June 30, 2014 –

Semi-annual Cash interest to be paid = face value of the bond x stated interest rate x ½

= $740,000 x 12% x ½ = $44,400

1. December 31, 2014 –

Semi-annual cash interest to be p aid = face value of the bond x stated interest rate x ½

= $740,000 x 12% x ½ = $44,400

1. Determination of the book value of the bonds on

1. June 30, 2014 –

Book value of bonds = total issue price – premium amortized

Total issue price = $832,219

Premium amortized = cash interest paid – interest expense

= $44,400 - $41,611 = $2,789

Premium amortized = $2,789

Book value = $832,219 - $2,789 = $829,430

1. December 31, 2014 –

Book value of bonds = book value as on June 30, 2014 – premium amortized

Book value as on June 30, 2014 = $829,430

Premium amortized = Cash interest paid – interest expense

= $44,400 - $41,472 = $2,928

Book value as on Dec 31, 2014 = 829,430 - $2,928 = $826,502