Chapter 10, Problem 22BE

a.

To determine

Prepare an amortization table.

Explanation of Solution

Amortization Schedule:

A schedule that gives the detail about each loan payment and shows the allocation of principal and interest over the life of the note, or bond is called amortization schedule.

Amortization table is prepared as follows:

Figure (1)

Working notes:

Calculate the cash payment from Year 1 to Year 5:

$\begin{array}{c}\text{Cash}\text{payment}\text{=}\text{Face}\text{value}\text{of}\text{bond}\text{×}\text{Stated}\text{rate}\text{of}\text{interest}\text{on}\text{bond}\\ \text{=}\text{\$120,000}\text{×}8\text{\%}\\ \text{=}\text{\$9,600}\end{array}$ (1)

Calculate the interest Expense as on December 31, Year 1:

$\begin{array}{c}\text{Interest}\text{Expense}\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{of}\text{bond}\text{as}\text{on}\text{January1,Year1}\\ \text{×Effective}\text{rate}\text{of}\text{interest}\end{array}\right)\\ \text{=}\text{\$124,920×7\%}\\ \text{=}\text{\$8,744}\end{array}$ (2)

Calculate the premium amortization as on December 31, Year 1:

$\begin{array}{c}\text{Premium}\text{amortization}\text{=}\text{Cash}\text{payment}-\text{Interest}\text{Rate}\\ \text{=}\text{\$9,600 (1)}-\text{\$8,744 (2)}\\ \text{=}\text{\$856}\end{array}$ (3)

Calculate the carrying value of bond as on December 31, Year 1:

$\begin{array}{c}\begin{array}{l}\text{Carrying value}\text{of}\text{bond}\text{as}\\ \text{on}\text{December31,year}\text{1}\end{array})\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{at}\text{thebeginning}\text{of}\text{the}\text{period}\text{as}\text{on}\\ \text{January1,Year1}-\text{The}\text{portion}\text{of}\text{the}\text{premium}\text{amortized}\end{array}\right)\\ \text{=\$124,920}-856\text{ (3)}\\ \text{=\$124,064}\end{array}$ (4)

Calculate the interest Expense as on December 31, Year 2:

$\begin{array}{c}\text{Interest}\text{Expense}\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{of}\text{bond}\text{as}\text{on}\text{December}\text{31,Year1}\\ \text{×Effective}\text{rate}\text{of}\text{interest}\end{array}\right)\\ \text{=}\text{\$124,064 (4)×7\%}\\ \text{=}\text{\$8,684}\end{array}$ (5)

Calculate the premium amortization as on December 31, Year 2:

$\begin{array}{c}\text{Premium}\text{amortization}\text{=}\text{Cash}\text{payment}-\text{Interest}\text{Rate}\\ \text{=}\text{\$9,600 (1)}-\text{\$8,684 (5)}\\ \text{=}\text{\$916}\end{array}$ (6)

Calculate the carrying value of bond as on December 31, Year 2:

$\begin{array}{c}\begin{array}{l}\text{Carrying value}\text{of}\text{bond}\text{as}\\ \text{on}\text{December31,year2}\end{array})\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{at}\text{thebeginning}\text{of}\text{the}\text{period as}\text{on}\\ \text{December}\text{31,Year1}-\text{The}\text{portion}\text{of}\text{the}\text{premium}\text{amortized}\end{array}\right)\\ \text{=\$124,064 (5)}-916\text{ (6)}\\ \text{=\$123,148}\end{array}$ (7)

Calculate the interest Expense as on December 31, Year 3:

$\begin{array}{c}\text{Interest}\text{Expense}\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{of}\text{bond}\text{as}\text{on}\text{December}\text{31,Year2}\\ \text{×Effective}\text{rate}\text{of}\text{interest}\end{array}\right)\\ \text{=}\text{\$123,148 (7)×7\%}\\ \text{=}\text{\$8,620}\end{array}$ (8)

Calculate the premium amortization as on December 31, Year 3:

$\begin{array}{c}\text{Premium}\text{amortization}\text{=}\text{Cash}\text{payment}-\text{Interest}\text{Rate}\\ \text{=}\text{\$9,600 (1)}-\text{\$8,620 (8)}\\ \text{=}\text{\$980}\end{array}$ (9)

Calculate the carrying value of bond as on December 31, Year 3:

$\begin{array}{c}\begin{array}{l}\text{Carrying value}\text{of}\text{bond}\text{as}\\ \text{on}\text{December31,year3}\end{array})\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{at}\text{thebeginning}\text{of}\text{the}\text{period as}\text{on}\\ \text{December}\text{31,Year2}-\text{The}\text{portion}\text{of}\text{the}\text{premium}\text{amortized}\end{array}\right)\\ \text{=\$123,148 (7)}-980\text{ (9)}\\ \text{=\$122,168}\end{array}$ (10)

Calculate the interest Expense as on December 31, Year 4:

$\begin{array}{c}\text{Interest}\text{Expense}\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{of}\text{bond}\text{as}\text{on}\text{December}\text{31,Year3}\\ \text{×Effective}\text{rate}\text{of}\text{interest}\end{array}\right)\\ \text{=}\text{\$122,168 (10)×7\%}\\ \text{=}\text{\$8,552}\end{array}$ (11)

Calculate the premium amortization as on December 31, Year 4:

$\begin{array}{c}\text{Premium}\text{amortization}\text{=}\text{Cash}\text{payment}-\text{Interest}\text{Rate}\\ \text{=}\text{\$9,600}\text{(1)}-\text{\$8,552 (11)}\\ \text{=}\text{\$1,048}\end{array}$ (12)

Calculate the carrying value of bond as on December 31, Year 4:

$\begin{array}{c}\begin{array}{l}\text{Carrying value}\text{of}\text{bond}\text{as}\\ \text{on}\text{December31,year4}\end{array})\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{at}\text{thebeginning}\text{of}\text{the}\text{period}\text{as}\text{on}\\ \text{December}\text{31,Year3}-\text{The}\text{portion}\text{of}\text{the}\text{premium}\text{amortized}\end{array}\right)\\ \text{=\$122,168 (10)}-\text{1,048 (12)}\\ \text{=\$121,120}\end{array}$ (13)

Calculate the interest Expense as on December 31, Year 5:

$\begin{array}{c}\text{Interest}\text{Expense}\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{of}\text{bond}\text{as}\text{on}\text{December}\text{31,Year4}\\ \text{×Effective}\text{rate}\text{of}\text{interest}\end{array}\right)\\ \text{=}\text{\$121,120 (13)×7\%}\\ \text{=}\text{\$8,480}\end{array}$ (14)

Note: $8,478.4 rounded to $10,597.

Calculate the premium amortization as on December 31, Year 5:

$\begin{array}{c}\text{Premium}\text{amortization}\text{=}\text{Cash}\text{payment}-\text{Interest}\text{Rate}\\ \text{=}\text{\$9,600 (1)}-\text{\$8,480(14)}\\ \text{=}\text{\$1,120}\end{array}$ (15)

Calculate the carrying value of bond as on December 31, Year 5:

$\begin{array}{c}\begin{array}{l}\text{Carrying value}\text{of}\text{bond}\text{as}\\ \text{on}\text{December31,year}\text{5}\end{array})\text{=}\left(\begin{array}{l}\text{Carrying}\text{value}\text{at}\text{thebeginning}\text{of}\text{the}\text{period}\text{as}\text{on}\\ \text{December}\text{31,Year4}-\text{The}\text{portion}\text{of}\text{the}\text{premium}\text{amortized}\end{array}\right)\\ \text{=\$121,120 (13)}-\text{1,120 (15)}\\ \text{=\$120,000}\end{array}$ (16)

b.

To determine

State the item that would appear on the Balance sheet of Year 3.

Explanation of Solution

Balance sheet:

Balance is the financial statement that reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

• The item that would appear on the Balance sheet of Year 3 is the carrying value of bond liability. The premium amount is included while, reporting the carrying value ($122,168).
• The face value of the bond and the premium received on bond is disclosed in the notes to the financial statements. Alternatively, the face value plus the premium could be shown in the following way:

Particulars	Amount ($)
Bond liability	120,000
Add: Bond Premium (17)	2,168
Carrying value	122,168

Table (2)

Working note:

Calculate the total premium on bond:

$\begin{array}{c}\text{Total}\text{premium}\text{on}\text{bond}\text{=}\left(\begin{array}{l}\text{Premium}\text{amortization}-\text{Amortization}\text{of}\text{year}\text{1}\\ -\text{Amortization}\text{of}\text{year}\text{2}-\text{Amortization}\text{of}\text{year}\text{3}\end{array}\right)\\ \text{=}\text{\$4,920}-\text{\$856}-\text{\$916}-\text{\$980}\\ \text{=\$2,168}\end{array}$ (17)

c.

To determine

State the item that would appear on the income statement of Year 3.

Explanation of Solution

Income statement:

Income statement is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

The statement of income will report interest expense of $8,620.

d.

To determine

State the item that would appear on the statement of cash flows of Year 3.

Explanation of Solution

Statement of cash flows:

Statement of cash flows is one among the financial statement of a Company statement that

Shows aggregate data of all cash inflows and cash outflows that is received and paid by the Company from its ongoing business operations.

The cash flow statement will report cash outflow of $9,600 for interest expense in the operating activities section of Year 3.