Chapter 10, Problem 7PA

1.

To determine

Prepare a bond amortization schedule.

Explanation of Solution

Amortization Schedule: An amortization schedule is a table that shows the details of each loan payment allocated between the principal amount and the overdue interest along with the beginning and ending balance of the loan. From the amortization schedule of the loan, the periodical interest expense, total interest expense and total payment made are known.

Prepare a bond amortization schedule as below:

Bond discount amortization schedule – Effective- Interest Amortization Method
Year Ending December 31	Interest Expense (Carrying value x 4%) (A)	Cash Paid (Face value x 3%) (B)	Discount Amortized $\left(C\right)=\left(A-B\right)$	Bonds Payable (D)	Discount on Bonds Payable (E)	Carrying Value $\left(F\right)=\left(D-E\right)$
01/01/2018	-	-	-	$600,000	$16,648 (1)	$583,352
12/31/2018	$23,334	$18,000	$5,334	$600,000	$11,314	$588,686
12/31/2019	$23,547	$18,000	$5,547	$600,000	$5,767	$594,233
12/31/2020	$23,767 (rounded)	$18,000	$5,767	$600,000	0	$600,000

Table (1)

Working note (1):

Calculate discount on bonds payable on 01/01/2015.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\begin{array}{l}\text{Face value }\\ -\text{ Cash received}\end{array}\right)\\ =\$600,000-\$583,352\\ =\$16,648\end{array}$

Note: Discount on bonds payable for each period is calculated by the following formula:

$\text{Discount on bonds payable = Previous balance of discount on bonds payable}–\text{Discount amortized}$

2.

To determine

Prepare journal entry to record the issuance of bonds on January 1, 2018.

Explanation of Solution

Bonds: Bonds are long-term promissory notes that are represented by a company while borrowing money from investors to raise fund for financing the operations.

Bonds Payable: Bonds payable are referred to long-term debts of the business, issued to various lenders known as bondholders, generally in multiples of $1,000 per bond, to raise fund for financing the operations.

Discount on bonds payable: It occurs when the bonds are issued at a low price than the face value.

Effective-interest amortization method: Effective-interest amortization method it is an amortization model that apportions the amount of bond discount or premium based on the market interest rate.

Prepare journal entry for cash proceeds from the issuance of the bonds on January 1, 2018.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
January 1, 2018	Cash		583,352
	Discount on Bonds Payable  (2)		16,648
	Bonds Payable			600,000
	(To record issuance of bonds payable at discount)

Table (2)

• Cash is an asset and it increases the value of assets. So, debit it by $583,352.
• Discount on Bonds Payable is an adjunct liability account and it decreases the value of liabilities. So, debit it by $16,648.
• Bonds payable is a liability and it increases the value of liabilities. So, credit it by $600,000.

Working note (2):

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable = }\left(\text{Face value }-\text{ Cash received}\right)\\ =\$600,000-\$583,352\\ =\$16,648\end{array}$

3.

To determine

Prepare journal entry to record the interest payment on December 31, 2018 and 2019.

Explanation of Solution

Prepare journal entry for payment of interest and amortization of discount on bonds on December 31, 2018.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2018	Interest Expense (4)		23,334
	Discount on Bonds Payable  (5)			5,334
	Cash (3)			18,000
	(To record payment of interest and amortization of discount on bonds)

Table (3)

• Interest expense is a component of stockholder’s equity and it decreases the equity value. So, debit it by $23,334.
• Discount on Bonds Payable is an adjunct liability account and it increases the value of liabilities. So, credit it by $5,334.
• Cash is an asset and it decreases the value of assets. So, credit it by $18,000.

Working note (3):

Calculate the cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$600,000\times 3\%\times 1\\ =\$18,000\end{array}$

Working note (4):

Calculate the interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\$583,352\times 4\%\times 1\\ =\$23,334\end{array}$

Working note (5):

Calculate the discount amortized.

$\begin{array}{c}\text{Discount amortized}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$23,334-\$18,000\\ =\$5,334\end{array}$

Prepare journal entry for payment of interest and amortization of discount on bonds December 31, 2019.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2019	Interest Expense (7)		23,547
	Discount on Bonds Payable (8)			5,547
	Cash (6)			18,000
	(To record payment of interest and amortization of discount on bonds)

Table (4)

• Interest expense is a component of stockholder’s equity and it decreases the equity value. So, debit it by $23,547.
• Discount on Bonds Payable is an adjunct liability account and it increases the value of liabilities. So, credit it by $5,547.
• Cash is an asset and it decreases the value of assets. So, credit it by $18,000.

Working note (6):

Calculate the cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$600,000\times 3\%\times 1\\ =\$18,000\end{array}$

Working note (7):

Calculate the interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$583,352+\$5,334\right)\times 4\%\times 1\\ =\$23,547\end{array}$

Working note (8):

Calculate the discount amortized.

$\begin{array}{c}\text{Discount amortized}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$23,547-\$18,000\\ =\$5,547\end{array}$

4.

To determine

Prepare journal entry to record the interest and face value payment on December 31, 2020.

Explanation of Solution

Prepare journal entry for payment of interest and face value.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
December 31, 2020	Interest Expense (10)		23,767
	Bonds Payable		600,000
	Discount on Bonds Payable (11)			5,767
	Cash			618,000
	(To record payment of interest and face value)

Table (5)

• Interest expense is an expense and it decreases the equity value. So, debit it by 23,767.
• Bonds payable is a liability and it is decreased. So, debit it by $600,000.
• Discount on Bonds Payable is an adjunct liability account and itis increased. So, credit it by $5,767.
• Cash is an asset and it decreases the value of assets. So, credit it by $618,000.

Working note (9):

Calculate the cash interest payment.

$\begin{array}{c}\text{Cash Interest Payment}=\left(\begin{array}{l}\text{Face value}\times \text{Stated interest rate}\\ \times \text{Interest time period}\end{array}\right)\\ =\$600,000\times \frac{3}{100}\times 1\\ =\$18,000\end{array}$

Working note (10):

Calculate the interest expense.

$\begin{array}{c}\text{Interest expense}=\text{Carrying amount }\times \text{Market interest}\times \text{Time}\\ =\left(\$583,352+\$5,334+\$5,547\right)\times \frac{4}{100}\times 1\\ =\$23,767\end{array}$

Working note (11):

Calculate the discount amortized.

$\begin{array}{c}\text{Discount amortized}=\text{Interest Expense}–\text{Cash interest payment }\\ =\$23,767(10)-\$18,000(11)\\ =\$5,767\end{array}$

5.

To determine

Prepare journal entry to record the bond retirement on January 1, 2020.

Explanation of Solution

Retirement of Bonds: The process of repaying the sale amount of bonds to bondholders at the time of maturity or before the maturity period is called as retirement of bonds. It is otherwise called as redemption of bonds.

Prepare Journal entry to record the bond retirement on January 1, 2020.

Date	Account Title and Explanation	Post Ref	Debit ($)	Credit ($)
January 1, 2020	Bonds Payable		600,000
	Loss on Retirement of Bonds (13)		11,767
	Discount on Bonds Payable			5,767
	Cash			606,000
	(To record the retirement of the bonds)

Table (6)

• Bonds payable is a liability and it is decreased. So, debit it by $600,000.
• Loss on retirement of bonds is an equity account and it is decreased. So, debit it by $11,767.
• Discount on Bonds Payable is an adjunct liability account and itis increased. So, credit it by $5,767.
• Cash is an asset and it is decreased. So, credit it by $606,000

Working note (12):

Calculate the carrying amount of bonds payable on the retirement.

$\begin{array}{c}\text{ Carrying amount of bonds payable = }\left(\text{Face value }-\text{Unamortized discount }\right)\\ =\$600,000-\$5,767\\ =\$594,233\end{array}$

Working note (13):

Compute loss on the redemption of the bonds payable.

$\begin{array}{c}\begin{array}{l}\text{Loss on redemption}\\ \text{ of bonds payable}\end{array}\}=\left(\begin{array}{l}\text{Cash paid to retire }\\ \text{the bonds}\end{array}\right)-\left(\begin{array}{l}\text{Carrying amount }\\ \text{of bonds payable}\end{array}\right)\\ =\left(\$600,000\times \frac{101}{100}\right)-\$594,233\text{ (12)}\\ =\$606,000-\$594,233\\ =\$11,767\end{array}$