FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY Flashcards
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
The following information pertains to Camp Corp.’s issuance of bonds on July 1, 20X3:
Face amount = $800,000
Term = Ten years
Stated interest rate = 6%
Interest payment dates annually on July 1 Yield = 9%
Present value-ten periods @ 9% = 0.422
Future value ten periods @ 9% = 2.367
Present value of ordinary annuity of one for ten periods @ 9% = 6.418
What should be the issue price for each $1,000 bond?
$864
$807
$700
$1,000
$807
EXPLANATION:
Each bond consists of a lump sum of $1,000 to be paid at the end of 10 years and an ordinary annuity of $60 per year for years, which consists of annual interest payments equal to 6% of $1,000, payable at the end of each period.
The proceeds from the issuance of each $1,000 bond will be the sum of the present value of those two components:
Amount X PV factor = PV
$1,000 X .422 = $422
$60 X 6.418 = $385
$807
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
Young Co. issues $800,000 of 10% bonds dated January 1, year 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in five years. The current market for similar bonds is 8%. The entire issue is sold on the date of issue.
The following values are given:
PV of Annuity PV of $1 N=10; i=0.04 8.11090 0.67556 N=10; i=0.05 7.72173 0.61391
What amount of proceeds on the sale of bonds should Young report?
$849,317
$815,564
$864,884
$799,997
$864,884
EXPLANATION:
The bond represents a stream of interest payments to be made twice per year over 5 years, and a single lump sum payment made at the end of 5 years.
Since the payments are made twice per year, 10 periods will be used, representing 5 years at 2 payments per year, with an interest rate of 4% per period, since each period represents ½ of a full year.
The interest, payable at the face of $800,000 x the stated rate of 10%, x ½ year, will be paid at the rate of $40,000 per period.
As a result, the present value of the payments to be made, which will be the proceeds of the bond, will consist of $40,000 x 8.11090 + $800,000 x
0.67556 or $324,436 + $540,448 = $864,884.
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
On January 1, a company issued a $50,000 face value, 8% five-year bond for $46,139 that will yield 10%. Interest is payable on June 30 and December 31.
What is the bond carrying amount on December 31 of the current year?
$46,139
$46,446
$47,106
$46,768
$47,106
EXPLANATION
The carry amount is the net amount at which the bond is being reported on the balance sheet. This equals the face value of bond plus the premium or minus the discount.
Since these bonds were issued at a discount they will have to pay a higher yielding interest rate of 10% per year.
However the cash payment for the bonds will still be 4% of $50,000 every six months.
The excess of $46,139 over 4% x $50,000 will be the discount amortization every payment period.
Date : Int pay | Int Exp | Amort | CV 1/1 Issue: 4%@$50,000 | 5% of CV=$46,139 6/30: $2,000 | $2,307 | $307 = $46,446 12/31: $2,000 | $2,322 | $322 = $46,768 6/30: $2,000 | $2,338 | $338 = $47,106
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
A company issues bonds at 98, with a maturity value of $50,000. The entry the company uses to record the original issue should include which of the following?
A credit to bonds payable of $49,000.
A credit to bond premium of $1,000.
A debit to bonds payable of $50,000.
A debit to bond discount of $1,000.
A debit to bond discount of $1,000.
EXPLANATION:
When a company issues a bond at 98, which means the proceeds will be 98% of the face value, with the difference recognized as a discount.
The proceeds will be $50,000 x 98% = $49,000.
The difference of $1,000 is the discount at issuance. The journal entry issuance would be:
Cash $49,000
Discount $ 1,000
B/P $50,000
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
The market price of a bond issued at a premium is equal to the present value of its principal amount…
Only, at the stated interest rate.
And the present value of all future interest payments, at the stated interest rate.
And the present value of all future interest payments, at the market (effective) interest rate.
Only, at the market (effective)
interest rate.
And the present value of all future interest payments, at the market (effective) interest rate.
EXPLANATION:
The market price of a bond, regardless of whether it is issued at a discount or a premium, is equal to the present value
of all cash flows that the bond represents.
This includes the present value of the principal amount and the present value of all
future interest payments.
The present value is computed using the bond’s effective rate of interest.
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
On June 30, 20X14, Ariadne, Inc. issued 2,500 of its 6%, ten-year, $1,000 face value bonds with detachable stock
warrants at par.
Each bond carried a detachable warrant for one share of Ariadne’s common stock at a specified option price of $24 per share.
Immediately after issuance, the market value of the bonds without the warrants was $2,250,000 and the market value of the warrants was $305,000.
In its December 31, 20X14 balance sheet,
what amount should Ariadne report as bonds payable, net of discount or premium? Assume straight-line amortization.
$2,195,000
$2,216,487
$2,216,565
$1,975,500
$2,216,487
EXPLANATION:
The proceeds of bonds issued with detachable warrants are allocated between the bonds and the warrants base upon their relative FMV at the time of issuance.
Since the bonds had a fair value of $2,250,000 and the warrants a fair
value of $305,000, the total of the fair values is $2,555,000.
The bonds account for 2,250,000 / 2,555,000 or 88.0626% of the proceeds of $2,500,000 or $2,201,565 and will be recorded, at issuance, at face of $2,500,000 minus a discount of
$298,435 for a net amount of $2,201,565.
The warrants account for 305,000 / 2,555,000 or 11.9374% of the proceeds of
$2,500,000 or $298,435.
On the balance sheet date straight-line bond discount amortization of $14,922 (29,844/2) would be recorded for a resulting bond payable, net of unamortized discount, of $2,216,487.
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
On June 1, Greendale Corp. issued $700,000, five-year bonds at 8%, with interest payable annually on May 31.
The bonds sold for $728,70 when the market rate of interest was 7%. Greendale uses the effective interest method for amortizing premiums on bonds payable.
What is the balance of the premiums on bonds payable account immediately following the first interest payment?
$23,709
$22,960
$34,440
$33,691
$23,709
EXPLANATION:
A premium on bonds payable is amortized by calculating the difference between interest paid, which is the face amount of the bond multiplied by the stated rate, and interest expense, which is the carrying amount of the bond times the effective interest rate.
Interest paid is $700,000 multiplied by 8%, or $56,000.
Interest expense in the first year is $728,700 multiplied by 7%, or $51,009.
Premium amortization is the difference of $4,991, reducing the premium to $28,700 - $4,991 or $23,709.
Face + Premium = CV
$700,000 + $28,700 = $728,700
CV x Effective Interest = Int Exp
$728,700 x 7% = $51,009
Int Exp - Cash Pay = Amortization Premium
$51,009 - $56,000 = $4991
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
The following information pertains to Camp Corp.’s issuance of bonds on July 1, 20X1:
Face amount - $800,000
Term - 10 years
Stated interest rate -6%
Interest payment dates- Annually on July 1
Yield - 9%
At 6% At 9%
PV of 10 periods 0.558 0.422
FV of 10 periods 1.791 2.367
PV of Annuity 7.630 6.418.
What should be the issue price for each $1,000 bond?
$807
$864
$1,000
$700
$807
EXPLANATION
Each $1,000 bond will involve annual interest payments equal to 6% of the face value or $60 per year which will be a ordinary annuity for 10 periods.
The present value at an effective interest rate of 9% is $60 x 6.418 or $385. It will also involve lump sum payment of $1,000 at the end of 10 periods.
At an effective interest rate of 9%, the present value is $1,000 x.422 is $422. The proceeds from the issuance of the bonds will be the total of $807.
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
During 20X2, Lake Co. issued 3,000 of its 9%, $1,000 face value bonds at 101 1/2. In connection with the sale of these bonds, Lake paid the following expenses:
Promotion costs = $20,000
Engraving and printing = $25,000
Underwriters’ commissions = $200,000
What amount should Lake record as bond issue costs to be amortized over the term of the bonds?
$220,000
$225,000
$0
$245,000
$245,000
EXPLANATION:
Bond issue costs include those costs a company incurs in order to be able to issue bonds.
Promotion costs, engraving and printing, and underwriters’ commissions would all be included for a total of $245,000.
FAR 11.03 - ISSUANCE OF BONDS: JOURNAL ENTRY
On June 1of the current year, Cross Corp. issued $300,000 of 8% bonds payable at par with interest payment dates of April 1 and October 1. In its income statement for the current year ended December 31, what amount of interest expense should Cross report?
$14,000
$8,000
$12,000
$6,000
$14,000
EXPLANATION:
Annual interest expense on a bond is the carrying value multiplied by the effective rate. When bonds are issued at par
the carrying value is the face value, $300,000, and the effective rate is the stated rate, 8%. As a result, annual interest is $24,000.
Since the bonds were issued on June 1, interest expense would be for 7 months resulting in a total of ($24,000 x 7/12) $14,000.
