Chapter 14, Problem 3PB

1.

To determine

Prepare journal entry to record the amount of cash proceeds from the issuance of the bonds on July 1, 2016.

Explanation of Solution

Prepare journal entry for cash proceeds from the issuance of the bonds on July 1, 2016.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Cash				73,100,469
July	1		Premium on Bonds Payable (1)				8,100,469
			Bonds Payable				65,000,000
				(To record issue of bonds at premium)

Table (1)

• Cash is an asset and it is increased. So, debit it by $73,100,469.
• Premium on Bonds Payable is an adjunct liability account and it is increased. So, credit it by $8,100,469.
• Bonds payable is a liability and it is increased. So, credit it by $65,000,000.

Working note (1):

Calculate premium on bonds payable.

$\begin{array}{c}\text{Premium on bonds payable = }\left(\begin{array}{l}\text{Cash received }\\ -\text{Face value }\end{array}\right)\\ =\$73,100,469-\$65,000,000\\ =\$8,100,469\end{array}$

2 (a)

To determine

Prepare journal entry to record first semiannual interest payment and amortization of bond premium on December 31, 2016.

Explanation of Solution

Prepare journal entry for first semiannual interest payment and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Interest Expense (4)				3,494,977
December	31	Premium on Bonds Payable  (2)				405,023
			Cash (3)				3,900,000
				(To record first semiannual payment of interest on bonds)

Table (2)

• Interest expense is an expense and it decreases the equity value. So, debit it by $3,494,977.
• Premium on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $405,023.
• Cash is an asset and it is decreased. So, credit it by $3,900,000.

Working notes:

(2)

Calculate premium on bonds payable semiannually.

$\begin{array}{c}\begin{array}{l}\text{Premium on bonds payable}\\ \text{semiannually}\end{array}\}=\left(\frac{\text{Premium on bonds payable per year}}{\text{Number}\text{of}\text{semiannual}}\right)\\ =\frac{\$8,100,469}{20}\\ =\$405,023\end{array}$

(3)

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$65,000,000\times 12\%\times \frac{6}{12}\\ =\$3,900,000\end{array}$

(4)

Calculate the interest expense on the bond.

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Cash}\text{Interest }-\text{ Premium}\text{ on}\text{ bonds}\text{ payable}\\ =\$3,900,000-\$405,023\\ =\$3,494,977\end{array}$

2 (b)

To determine

Prepare journal entry to record second interest payment and amortization of bond discount on June 30, 2017.

Explanation of Solution

Prepare journal entry for second interest payment and amortization of discount on bonds.

Date		Account Title and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Interest Expense (7)				3,494,977
June	30	Premium on Bonds Payable  (5)				405,023
			Cash (6)				3,900,000
				(To record second semiannual payment of interest on bonds)

Table (3)

• Interest expense is an expense and it decreases the equity value. So, debit it by $3,494,977.
• Premium on Bonds Payable is an adjunct liability account and it is decreased. So, debit it by $405,023.
• Cash is an asset and it is decreased. So, credit it by $3,900,000.

Working notes:

(5)

Calculate premium on bonds payable semiannually.

$\begin{array}{c}\begin{array}{l}\text{Premium on bonds payable}\\ \text{semiannually}\end{array}\}=\left(\frac{\text{Premium on bonds payable per year}}{\text{Number}\text{of}\text{semiannual}}\right)\\ =\frac{\$8,100,469}{20}\\ =\$405,023\end{array}$

(6)

Calculate the amount of cash interest.

$\begin{array}{c}\text{ Cash interest = }\left(\begin{array}{l}\text{Face value}\times \text{Face interest rate}\times \\ \text{Interest}\text{time}\text{period}\end{array}\right)\\ =\$65,000,000\times 12\%\times \frac{6}{12}\\ =\$3,900,000\end{array}$

(7)

Calculate the interest expense on the bond.

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Cash}\text{Interest }-\text{ Premium}onBondsPayable\\ =\$3,900,000-\$405,023\\ =\$3,494,977\end{array}$

3.

To determine

Determine the amount of total interest expense for 2016.

Explanation of Solution

Determine the amount of total interest expense for 2016.

$\begin{array}{c}\text{Total interest expense for Year 1 = }\left(\begin{array}{l}\text{ Interest paid in }2016\\ -\text{Premium amortized in }2016\end{array}\right)\\ =\$3,900,000-\$405,023\\ =\$3,494,977\end{array}$

Conclusion

 Hence, the amount of total interest expense for 2016 is $3,494,977.

4.

To determine

Explain the situation when contract rate of bond is greater than the market rate of interest.

Explanation of Solution

Yes, the bond proceeds will always be greater than the face amount of bonds when the contract interest rate is greater than the market interest rate.

If the stated interest rate of a bond is greater than the market interest rate, then the bonds is issued at premium. This is because the bonds are more valuable in market and investors are ready to pay more than the maturity value of bonds.

5.

To determine

Calculate the amount of cash proceeds (present value) from the sale of the bonds using present value tables.

Explanation of Solution

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

Step 1: Calculate the semiannual interest on bonds.

$\begin{array}{c}\text{Interest}=\text{Face value}\times \text{Face interest rate}\times \text{Interest time period}\\ =\$65,000,000\times 12\%\times \frac{6}{12}\\ =\$3,900,000\end{array}$

Step 2: Calculate the present value of interest.

Particulars	Amount
Interest payment (a)	$3,900,000
PV factor at semiannual market interest rate of 5% for 20 periods (b)	12.46221
Present value [(a) × (b)]	$48,602,619

Table (4)

Note: Refer Appendix A in the text book for present value factor.

Step 3: Calculate the present value of lump sum payment of $65,000,000 (principal amount) at 5% for 20 periods.

Particulars	Amount
Single payment (a)	$65,000,000
PV factor at semiannual market interest rate of 5% for 20 periods (b)	0.37689
Present value [(a) × (b)]	$24,497,850

Table (5)

Note: Refer Appendix A in the text book for present value factor.

Step 4: Calculate the amount of cash proceeds from the sale of the bonds.

$\begin{array}{c}\text{Cash proceeds from sale of bonds }=\left(\begin{array}{c}\text{Present value of interest payment} \\ +\text{ Present value of Lump sum payment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$48,602,619}\left(\text{from table 4}\right)\\ +\text{\$24,497,850}\left(\text{from table 5}\right)\end{array}\right)\\ =\text{\$73,100,469}\end{array}$

Conclusion

Thus, the amount of cash proceeds from the sale of the bonds is $73,100,469.