Chapter 14, Problem 10BPSB

To determine

1)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. They are issued at par, at premium or at a discount.

• Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

Journal Entries

• Journal entries are the first step in recording financial transactions and preparation of financial statements.

• These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.

• Assets and expenses have debit balances and Liabilities and Incomes have credit balances and according to the business transaction, the accounts are appropriately debited will be credited by credited to reflect the effect of business transactions and events.

To Prepare:

Journal entry to record issuance of bonds

Answer to Problem 10BPSB

Solution:

Date	Particulars	Debit	Credit
January 1,2017	Bank	$493,608
	13% Bonds Payable		$450,000
	Premium on Issue of Bonds		$43,608
	(Being cash received for issue of 13% bonds payable of $450,000)

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• Assets and Expenses have debit balances and must be debited in order to increase their balance and credited in order to decrease their balance.

• Liabilities and Incomes have credit balances and must be debited in order to decrease their balance and credited in order to increase their balance.

• On January 1,2017 Bank will be debited by $493,608, 13% Bonds Payable will be credited by $450,000 and Premium on Issue of Bonds will be credited by $43,608 since cash was received for issue of 13% bonds payable of $450,000 and the excess of issue price over par value is credited on Premium on Issue of Bonds.

• Bank is an asset and must be debited to indicate increase in balances. Bonds Payable and Premium on issue are liabilities and must be credited to indicate increase in balances.

Conclusion

Hence the transaction of issuance of bonds has been journalized.

To determine

2)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. These payments may be annual or semi-annual in nature and represent steady income and positive cash flows for investors

• Bonds are issued at par, at premium or at a discount. Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

To Determine:

Interest Expense to be recognized over bond’s life

Answer to Problem 10BPSB

Solution:

Interest Expense to be recognized over bond’s life is $190,392

Explanation of Solution

Particulars	Amount ($)
Par Value	$ 450,000.00
Rate of Interest	13%
Duration of Bonds	4
Frequency of interest Payments	Semi - Annual
Interest Payable	$ 234,000.00
Premium on Issue received	$ 43,608.00
Net Interest Expense to be recognized	$ 190,392.00

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• The company issued 4 years 13% Bonds Payable with Par value of $450,000. Interest payable over a period of 4 years is calculated as product of Par Value, Rate of Interest and Duration of Bonds. Interest expense payable on Bonds is $252,000.

• Since the company has issued bonds at premium owing to the higher rate of interest of 13% as opposed to the market rate of 10%, premium on issue of bonds of $43,608 was received.

• This premium is to be amortized over the lifetime of the bonds against the interest expense payable and the net interest expense payable is calculated as the difference of Interest payable of $234,000 and premium on issue of $43,608 and is $190,392.

Conclusion

Hence interest payable on bonds has been calculated.

To determine

3)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. These payments may be annual or semi-annual in nature and represent steady income and positive cash flows for investors.

• Interest expense paid has to be amortized by the company over the lifetime of the bonds. Any premium received on issue is reduced from the interest expense and the net expense is amortized over the lifetime of the bonds.

• Bonds are issued at par, at premium or at a discount. Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

To Prepare:

Interest Amortization Table

Answer to Problem 10BPSB

Solution:

Bond Discount Amortization
Period	Date	Interest Paid Semi -Annually @ 13%	Market Rate of Interest Paid Semi - Annually @ 10%	Amortization Of Premium	Unamortized Premium	Net Book Value (For Effective Interest Calculation)
		[A]	[B]	[ A-B ]	[E]	[F] = [ $450,000 + E]
		(13% x 1/2 x 450,000)	(F x 10% x 1/2)
-	01-01-17				43,608	493,608
1	30-06-17	29,250	24,680	4,570	39,038	489,038
2	31-12-17	29,250	24,452	4,798	34,240	484,240
3	30-06-18	29,250	24,212	5,038	29,202	479,202
4	31-12-18	29,250	23,960	5,290	23,912	473,912
5	30-06-19	29,250	23,696	5,554	18,358	468,358
6	31-12-19	29,250	23,418	5,832	12,526	462,526
7	30-06-20	29,250	23,126	6,124	6,402	456,402
8	31-12-20	29,250	22,820	6,402	0	450,000

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• The method of amortization of interest is effective-interest amortization method. In this method, the effective rate of interest is the market rate of interest on the date of issue of the bonds.

• Market rate of interest is 10% and Interest paid on bonds is 13%. Since the interest payments are semi-annual, the interest is calculated accordingly.

• The amount on which effective interest is calculated is the actual amount received from issue of bonds i.e. Par value plus Premium on Issue of Bonds for the first period and the net book value after premium amortized for the subsequent periods.

• The difference between the effective interest and actual interest paid is the amount of premium amortized during the period. During the last period the balance of unamortized premium is zero and the net interest expense payable over the lifetime of the bonds is reduced the premium received on issue.

Conclusion

Hence the interest amortization table is prepared.

To determine

4)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. They are issued at par, at premium or at a discount.

• Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

Journal Entries

• Journal entries are the first step in recording financial transactions and preparation of financial statements.

• These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.

• Assets and expenses have debit balances and Liabilities and Incomes have credit balances and according to the business transaction, the accounts are appropriately debited will be credited by credited to reflect the effect of business transactions and events.

To Prepare:

Journal entry to record first two interest payments on bonds

Answer to Problem 10BPSB

Solution:

Date	Particulars	Debit ($)	Credit ($)
06.30.19	Interest Expense	$24,680
	Premium on Issue of Bonds	$4,570
	Cash		$29,250
	(Being interest paid and premium on issue of bonds amortized)
12.31.19	Interest Expense	$24,452
	Premium on Issue of Bonds	$4,570
	Cash		$29,250
	(Being interest paid and premium on issue of bonds amortized)

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par. If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• The method of amortization of interest is effective-interest amortization method. In this method, the effective rate of interest is the market rate of interest on the date of issue of the bonds.

• Market rate of interest is 10% and Interest paid on bonds is 13%. Since the interest payments are semi-annual, the interest is calculated accordingly.

• The amount on which effective interest is calculated is the actual amount received from issue of bonds i.e. Par value plus Premium on Issue of Bonds for the first period and the net book value after premium amortized for the subsequent periods.

• The difference between the effective interest and actual interest paid is the amount of premium amortized during the period

• Bonds Payable is a liability and therefore has a credit balance. In order to create the liability, they are credited. Cash is an asset and hence must be debited to indicate increase in balance.

• The difference between the face value of bonds payable and issue proceeds is the premium on issue of bonds. Since the premium on issue is amortized as per the effective interest method, the same is amortized with every interest payment.

Conclusion

Hence the transactions for the first two interest payments have been journalized.

To determine

5)

Introduction:

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. They are issued at par, at premium or at a discount.

• Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

Journal Entries

• Journal entries are the first step in recording financial transactions and preparation of financial statements.

• These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.

• Assets and expenses have debit balances and Liabilities and Incomes have credit balances and according to the business transaction, the accounts are appropriately debited will be credited by credited to reflect the effect of business transactions and events.

To Prepare:

Journal entry to record retirement of bonds at 106

Answer to Problem 10BPSB

Solution:

Date	Particulars	Debit ($)	Credit ($)
01.01.19	13% Bonds Payable	$450,000
	Premium on Issue of Bonds	$23,912
	Loss on Retirement of Bonds	3,088
	Cash		$477,000
	(Being bonds retired at 98 and premium on issue of bonds amortized against gain on retirement of bonds)

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par. If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• The method of amortization of interest is effective-interest amortization method. In this method, the effective rate of interest is the market rate of interest on the date of issue of the bonds.

• Market rate of interest is 10% and Interest paid on bonds is 13%. Since the interest payments are semi-annual, the interest is calculated accordingly. The amount on which effective interest is calculated is the actual amount received from issue of bonds i.e. Par value plus Premium on Issue of Bonds for the first period and the net book value after premium amortized for the subsequent periods.

• The difference between the effective interest and actual interest paid is the amount of premium amortized during the period.

• When bonds are retired, the retirement may be performed at the par value, at a profit or at a loss. If the repayment price equals the par value, the bonds are said to be repayment at par.

• If the repayment price is less than the par value, the bonds are said to be repaid at a profit. If the repayment price exceeds the par value, the bonds are said to be repaid at a loss. Any profits or losses on retirement are calculated after adjusting the balance of unamortized premium on issue since it is a liability.

• On 01.01.19, 13% Bonds Payable will be debited by $450,000, Premium on Issue of Bonds will be debited by $23,912, Loss on Retirement of Bonds will be debited by $3,088 and Cash will be credited by $477,400 since bonds were retired at 98 and premium on issue of bonds was amortized against gain on retirement of bonds.

• Cash paid on retirement is calculated as $450,000 x 106 / 100 = $477,000 since the bonds were retired at 106. Unamortized Premium on Issue of Bonds as on 1^st January 2019 is $23,912 as per the interest amortization table and must be charged against profit on retirement of bonds.

• Loss on Retirement of Bonds is calculated as difference of carrying amount of bonds as on1^st January 2019 of $473,912 and net cash paid of $477,000 and is $3,088.

Conclusion

Hence the transaction of retirement of bonds is journalized.

To determine

6)

Introduction:

General Purpose Financial Statements:

• Financial statements are financial records of the entities transactions for a given reporting period and indicate the financial health of an entity. They comprise of:

1. Income Statements and Notes to Income Statement,

2. Balance Sheets and,

3. Cash flow statements.

• Income Statements and Notes to Income Statement record the results of the company’s operations during a particular reporting period and provide information about the sources of funds and expenses of an entity.

• Balance Sheet is a list of the closing balance of assets and liabilities of an entity as on a particular date and it is used for analysis of the financial health of the entity.

• Cash flow statements are a record of the cash inflows and cash outflows of an entity during a reporting period. It analyses the cash flows pertaining to operating activities, investing activities and financing activities.

Bonds

• Bonds are long term negotiable instruments of debt issued by corporate entities to secure funds and fund either long term capital expenditure or similar long term investment opportunities.

• Bonds are accompanied by periodic interest payments. They are issued at par, at premium or at a discount.

• Bonds when issued at a discount represent a loss to the company since the repayment value is more than the value of the Bonds borrowed.

To Determine:

Impact of market rate of interest of 14% instead of 10% on financial statements

Answer to Problem 10BPSB

Solution:

If the market rate of interest was 14% instead of 10%, then the bonds would be issued at a discount and the interest expense recognized over the lifetime of the bonds would be higher, thus having an adverse impact on profitability.

Explanation of Solution

• When a company decides to issue bonds, it can do so at par, at a premium or at a discount. If the issue price equals the par value, the bonds are said to be issued at par.

• If the issue price is less than the par value, the bonds are said to be issued at a discount. If the issue price exceeds the par value, the bonds are said to be issued at a premium

• Bonds are issued at a discount when the market rate of interest is higher than the interest paid on the bonds and they are issued at a premium when the market rate of interest is lower than the interest paid on the bonds.

• If the market rate of interest is higher than the interest paid on the bonds, then the investor interest would be lower and hence the bonds would have to be issued at a discount. The bonds carrying value in the financial statements would be lower initially since carrying amount is calculated as difference of Par value and unamortized discount.

• The interest expense in the income statement would increase since the discount on issue would also need to be amortized over the lifetime of the bonds and would be added to interest expense of bonds recognized in the income statement.

• The cash flow statements prepared would show lower cash flows from financing activities owing to lower cash received during issuance of bonds.

Conclusion

Hence the impact of change in interest rate on financial statements is explained.