   Chapter 14, Problem 14.25EX

Chapter
Section
Textbook Problem

Compute bond proceeds, amortizing premium by interest method, and interest expenseWare Co. produces and sells motorcycle parts. On the first day of its fiscal year, Ware Co. issued $35,000.000 of five-year, 12% bonds at a market (effective) interest rate of 10%, with interest payable semiannually. Compute the following, presenting figures used in your computations:a. The amount of cash proceeds from the sale of the bonds. Use the tables of present values in Exhibits 8 and 10. Round to the nearest dollar.b. The amount of premium to be amortized for (he first semiannual interest payment period, using the interest method. Round to the nearest dollar.c. The amount of premium to lie amortized for the second semiannual interest payment period, using the interest method. Round to the nearest dollar.d. The amount of the bond interest expense for the first year. (a) To determine 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.

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

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

Present Value: The value of today’s amount expected to be paid or received in the future at a compound interest rate is called as present value.

To calculate: The amount of cash proceeds (present value) from the sale of the bonds.

Explanation

Determine the amount of cash proceeds (present value) from the sale of the bonds.

Step 1: Calculate the semiannual interest on bonds.

Interest=Face value×Face interest rate×Interest time period=$35,000,000×12%×612=$2,100,000

Step 2: Calculate the present value of interest.

 Particulars Amount Interest payment (a) $2,100,000 PV factor at semiannual market interest rate of 5% for 10 periods (b) 7.72173 Present value (a)×(b)$16,215,633

Table (1)

Note: The present value factor for 10 periods at 5% interest would be 7.72173 (Refer Exhibit 10 in the chapter for present value factor).

Step 3: Calculate the present value of lump sum payment of $35,000,000 (principal amount) at 5% for 10 periods.  Particulars Amount Single payment (a)$35,000,000 PV factor at semiannual market interest rate of 5% for 10 periods (b) 0

(b)

To determine

To calculate: The amount of premium to be amortized for the first semiannual interest payment period.

(c)

To determine

To calculate: The amount of premium to be amortized for the second semiannual interest payment period.

(d)

To determine
The amount of bond interest expense for first year.

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