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Demonstration Problem Chapter 7 – Problem 31 Bonds Payable – Calculate Issue Price and Amortize Discount Accounting What the Numbers Mean 10e
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Demonstration Problem
Chapter 7 – Problem 31
Bonds Payable – Calculate Issue Price
and Amortize Discount
AccountingWhat the Numbers Mean 10e
Problem Definition
On January 1, 2013, Drennen, Inc., issued $3 million face
amount of 10-year, 14% stated rate bonds when market
interest rates were 12%. The bonds pay semiannual
interest each June 30 and December 31 and mature on
December 31, 2022.
Problem Definition
a. Using the present value tables in Chapter 6, calculate the proceeds (issue price) of Drennen, Inc.’s, bonds on January 1, 2013, assuming that the bonds were sold to provide a market rate of return to the investor.
b. Assume instead that the proceeds were $2,950,000. Use the horizontal model (or write the journal entry) to record the payment of semiannual interest and the related discount amortization on June 30, 2013, assuming that the discount of $50,000 is amortized on a straight-line basis.
c. If the discount in part b were amortized using the compound interest method, would interest expense for the year ended December 31, 2013, be more than, less than, or equal to the interest expense reported using the straight-line method of discount amortization? Explain.
Problem Solution
a. The semi-annual interest payments on the bonds =
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate
14%
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount
14%
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount
14% * $3,000,000
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14% * $3,000,000
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14% * $3,000,000 * 6/12 =
Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14% * $3,000,000 * 6/12 =
$210,000
This amount represents the cash interest payment that is due to the bondholder of record every six months throughout the life of the bond. This is true whether the bond is sold at a premium, at a discount, or at par.
Problem Solution
a. The term of the bond is 10 years,
Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
12%
Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
12% * 6/12 =
Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
12% * 6/12 = 6%
This is the interest rate used to discount the semi-annual cash interest payments of $210,000 each (i.e., the annuity) back to present value.
Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
$210,000
The semi-annual interest payment of $210,000 is…
Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
$210,000 * 11.4699 =
The semi-annual interest payment of $210,000 is…
multiplied by the present value of an annuity factor (n = 20, i = 6%) from Table 6-5 in the text…
Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
$210,000 * 11.4699 = $2,408,679
The semi-annual interest payment is…
multiplied by the present value of an annuity factor (n = 20, i = 6%) from Table 6-5 in the text…
to get the present value of the interest annuity.
Problem Solution
a. The present value of the maturity amount of $3,000,000 in 20 periods at 6% =
Problem Solution
a. The present value of the maturity amount of $3,000,000 in 20 periods at 6% =
$3,000,000
The par value of the bonds, which will be paid to the bondholder of record on the maturity date, is…
Problem Solution
a. The present value of the maturity amount of $3,000,000 in 20 periods at 6% =
$3,000,000 * 0.3118 =
The par value of the bonds, which will be paid to the bondholder of record on the maturity date, is…
multiplied by the present value of $1 factor (n = 20, i = 6%) from Table 6-4 in the text…
Problem Solution
a. The present value of the maturity amount
of $3,000,000 in 20 periods at 6% =
$3,000,000 * 0.3118 = $935,400
The par value of the bonds, which will be paid to the bondholder of record on the maturity date, is…
multiplied by the present value of $1 factor (n = 20, i = 6%) from Table 6-4 in the text…
to get the present value of the maturity amount.
Problem Solution
a. The proceeds (issue price) of the bonds =
Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest
Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest
$2,408,679
Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest + PV of maturity value =
$2,408,679
Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest + PV of maturity value =
$2,408,679 + $935,400 =
Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest + PV of maturity value =
$2,408,679 + $935,400 =
$3,344,079
Problem Definition
a. Using the present value tables in Chapter 6, calculate the proceeds (issue price) of Drennen, Inc.’s, bonds on January 1, 2013, assuming that the bonds were sold to provide a market rate of return to the investor.
b. Assume instead that the proceeds were $2,950,000. Use the horizontal model (or write the journal entry) to record the payment of semiannual interest and the related discount amortization on June 30, 2013, assuming that the discount of $50,000 is amortized on a straight-line basis.
c. If the discount in part b were amortized using the compound interest method, would interest expense for the year ended December 31, 2013, be more than, less than, or equal to the interest expense reported using the straight-line method of discount amortization? Explain.
Problem Solution
b. The semiannual discount amortization, straight-line basis =
Problem Solution
b. The semiannual discount amortization, straight-line basis =
$50,000
Problem Solution
b. The semiannual discount amortization, straight-line basis =
$50,000 / 20 periods =
Problem Solution
b. The semiannual discount amortization, straight-line basis =
$50,000 / 20 periods =
$2,500
Problem Solution
b.
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash -210,000
The cash payment of $210,000 each six months represents the par value of $3,000,000 times the market rate of interest of 12% times the period of time of 6/12.
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash Discount on -210,000 Bonds Payable +2,500
The amortization of bond discount increases the carrying value of the bonds from
$3,000,000 - $50,000 = $2,950,000 to
$3,000,000 - $47,500 = $2,952,500.
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash Discount on Interest -210,000 Bonds Payable Expense +2,500 -212,500
When bond discount is amortized, interest expense is
the sum (or addition) of the cash interest payment and the discount amortized.
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash Discount on Interest -210,000 Bonds Payable Expense +2,500 -212,500
Journal entry: Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash Discount on Interest -210,000 Bonds Payable Expense +2,500 -212,500
Journal entry: Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500 Cr. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $210,000
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash Discount on Interest -210,000 Bonds Payable Expense +2,500 -212,500
Journal entry: Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500 Cr. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $210,000 Cr. Discount on Bonds Payable . . . . . . . . . . . . . . 2,500
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Solution
b.
Cash Discount on Interest -210,000 Bonds Payable Expense +2,500 -212,500
Journal entry: Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500 Cr. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $210,000 Cr. Discount on Bonds Payable . . . . . . . . . . . . . . 2,500
The interest expense debit is the sum (or addition) of the Cash and Discount on Bonds Payable credits.
Balance Sheet Income Statement .
Assets = Liabilities + Stockholders’ Equity Net income = Revenues - Expenses
Problem Definition
a. Using the present value tables in Chapter 6, calculate the proceeds (issue price) of Drennen, Inc.’s, bonds on January 1, 2013, assuming that the bonds were sold to provide a market rate of return to the investor.
b. Assume instead that the proceeds were $2,950,000. Use the horizontal model (or write the journal entry) to record the payment of semiannual interest and the related discount amortization on June 30, 2013, assuming that the discount of $50,000 is amortized on a straight-line basis.
c. If the discount in part b were amortized using the compound interest method, would interest expense for the year ended December 31, 2013, be more than, less than, or equal to the interest expense reported using the straight-line method of discount amortization? Explain.
Problem Solution
c. Discount on bonds payable is amortized with a credit, and thus increases interest expense.
Problem Solution
c. Discount on bonds payable is amortized with a credit, and thus increases interest expense.
Under the straight-line basis, the amount of discount amortization is the same each period.
Problem Solution
c. Discount on bonds payable is amortized with a credit, and thus increases interest expense.
Under the straight-line basis, the amount of discount amortization is the same each period.
Under the compound (or effective) interest method, the amount of discount amortization increases each period.
Problem Solutionc. Discount on bonds payable is amortized with a credit,
and thus increases interest expense.
Under the straight-line basis, the amount of discount amortization is the same each period.
Under the compound (or effective) interest method, the amount of discount amortization increases each period.
Thus, interest expense under the compound method will be lower in the early years of the bond’s life, and higher in the later years, as compared to interest expense under the straight-line method of amortization.
AccountingWhat the Numbers Mean 10e
David H. MarshallWayne W. McManus
Daniel F. Viele
You should now have a better understandingof how to account for bonds payable.
Remember that there is a demonstration problem for each chapter that is here for your learning benefit.
