Question

On September 1, 2018, Evansville Lumber Company issued $80 million in 20-year, 10 percent

bonds payable. Interest is payable semiannually on March 1 and September 1. Bond discounts and

premiums are amortized at each interest payment date and at year-end. The company’s fiscal year

ends at December 31.

Instructions

a. Make the necessary adjusting entries at December 31, 2018, and the journal entry to record

the payment of bond interest on March 1, 2019, under each of the following assumptions.

1. The bonds were issued at 98. (Round to the nearest dollar.)

2. The bonds were issued at 101. (Round to the nearest dollar.)

b. Compute the net bond liability at December 31, 2019, under assumptions 1 and 2. (Round to

the nearest dollar.)

c. Under which of these assumptions, 1 or 2, would the investor’s effective rate of interest be

higher? Explain.

Answer 1

Solution a1:

Journal Entries - Evansville Lumber Company
Date	Particulars	Debit	Credit
31-Dec-18	Interest expense Dr	$2,693,334
	To Interest payable ($80,000,000*10%*4/12)		$2,666,667
	To Discount on issue of bond ($80,000,000*2%/40*4/6)		$26,667
	(To record interest accrued and discount amortized)
1-Mar-19	Interest expense Dr	$1,346,666
	Interest payable Dr	$2,666,667
	To Cash ($80,000,000*10%*6/12)		$4,000,000
	To Discount on issue of bond ($80,000,000*2%/40*2/6)		$13,333
	(To record semiannual interest payment)

Solution a2:

Journal Entries - Evansville Lumber Company
Date	Particulars	Debit	Credit
31-Dec-18	Interest expense Dr	$2,653,333
	Premium on issue of bond Dr ($80,000,000*1%/40*4/6)	$13,333
	To Interest payable ($80,000,000*10%*4/12)		$2,666,667
	(To record interest accrued and premium amortized)
1-Mar-19	Interest expense Dr	$1,326,666
	Interest payable Dr	$2,666,667
	Premium on issue of bond Dr ($80,000,000*1%/40*2/6)	$6,667
	To Cash ($80,000,000*10%*6/12)		$4,000,000
	(To record semiannual interest payment)

Solution b:

Net bond liability at Dec 31, 2019 under Assumption 1 = Bond Issue value + Discount amortized

= ($80,000,000*98%) + ($80,000,000*2%/40 + $80,000,000*2%/40 + $80,000,000*2%/40*4/6)

= $78,506,667

Net bond liability at Dec 31, 2019 under Assumption 2 = Bond Issue value - premium amortized

= ($80,000,000*101%) - ($80,000,000*1%/40 + $80,000,000*1%/40 + $80,000,000*1%/40*4/6)

= $80,800,000 - $53,333 = $80,746,667

Solution c:

Under assumption 1, when bonds are issued at discount, investor;'s effective rate of interest be higher.