Q41PGB - Horngren'S Financial And Managerial Accounting

Question

Analyzing and journalizing bond transactions

On January 1, 2018, Doctors Credit Union (DCU) issued 7%, 20-year bonds payable with face value of $200,000. The bonds pay interest on June 30 and December 31.

Requirements

1. If the market interest rate is 5% when DCU issues its bonds, will the bonds be priced at face value, at a premium, or at a discount? Explain.

2. If the market interest rate is 8% when DCU issues its bonds, will the bonds be priced at face value, at a premium, or at a discount? Explain.

3. The issue price of the bonds is 93. Journalize the following bond transactions:

a. Issuance of the bonds on January 1, 2018.

b. Payment of interest and amortization on June 30, 2018.

c. Payment of interest and amortization on December 31, 2018.

d. Retirement of the bond at maturity on December 31, 2037, assuming the last interest payment has already been recorded.

Step-by-Step Solution

Answer

Bond issued at premium at 5% and issued at discount at 8%. The amount of the interest expense is $7,350.

Step 1: Definition of interest amortization

The discount amortization is a process in which the discount is allocated to the interest expense.

Step 2: Issue bonds at a premium or discount

If the market interest rate is 5%, the bonds are issued at a premium because the stated interest rate is greater than the market interest rate.

Step 3: Issue bonds at a premium or discount

If the market interest rate is 8%, then the bonds are issued at a discount because the market interest rate is greater than the stated interest rate. 

Step 4: Journal entries related to the bonds

Date	Particulars	Debit	Credit
January 1, 2018	Cash	$186,000
	Discount on Bonds	$14,000
	Bonds Payable		$200,000
	(Being entry for the issue of the bonds)
June 30, 2018	Interest Expense	$7,350
	Discount on Bonds		$350
	Cash		$7,000
	(Being entry for the payment of interest)
December 31, 2018	Interest Expense	$7,350
	Discount on Bonds		$350
	Cash		$7,350
	(Being entry for the payment of interest)
December 31, 2037	8% Bonds Payable	$200,000
	Cash		$200,000
	(Being entry for the retirement of bonds)

$\begin{array}{c}\mathrm{Semi}-\mathrm{Annual}\hspace{0.17em}\hspace{0.17em}\mathrm{Interest}=\hspace{0.17em}\frac{\mathrm{Face}\hspace{0.17em}\mathrm{Value}\times \hspace{0.17em}\mathrm{Interest}\hspace{0.17em}\hspace{0.17em}\mathrm{rate}\times \hspace{0.17em}\mathrm{time}\hspace{0.17em}\mathrm{preiod}}{\mathrm{12}}\\ =\frac{\$200,000\times \hspace{0.17em}7\%\hspace{0.17em}\times \hspace{0.17em}6}{\mathrm{12}}\\ =\$7000\end{array}$