(Supplement 10B) Recording Bond Issue, Interest Payments (Effective-Interest Amortization), and Early Bond Retirement
Refer to PB 10-6. Assume Methodical uses the effective-interest bond amortization method.
Required:
- 1. Prepare a bond amortization schedule.
- 2. Give the
journal entry to record the bond issue. - 3. Give the journal entries to record the interest payments on December 31, 2015 and 2016.
- 4. Give the journal entry to record the interest and face value payment on December 31, 2017.
- 5. Assume the bonds are retired on January 1, 2017, at a price of 101. Give the journal entry to record the bond retirement.
1.
To prepare: Abond amortization schedule.
Explanation of Solution
Amortization Schedule: An amortization schedule is a table that shows the details of each loan payment allocated between the principal amount and the overdue interest along with the beginning and ending balance of the loan. From the amortization schedule of the loan, the periodical interest expense, total interest expense and total payment made are known.
Prepare bond amortization schedule as below:
Bond premium amortization schedule – Effective-interest amortization method | ||||||
Year Ending December 31 | Cash Paid (A) |
Interest Expense (B) |
Premium Amortized (C) = (A-B) |
Bonds Payable (D) |
Premium on Bonds Payable (E) |
Carrying Value (F) =(D+E) |
01/01/15 | – | – | – | $100,000 | $2,070 | $102,070 |
12/31/15 | $5,000 | $4,338 | $662 | $100,000 | $1,408 | $101,408 |
12/31/16 | $5,000 | $4,310 | $690 | $100,000 | $718 | $100,718 |
12/31/17 | $5,000 | $4,282 (rounded) |
$718 | $100,000 | 0 | $100,000 |
Table (1)
Working notes:
Calculate premium on bonds payable.
Calculate the amount of cash paid.
Premium on bonds payable for each period is calculated by the following formula:
2.
To prepare: Journal entry to record the issuance of the bonds on January 1, 2015.
Explanation of Solution
Bonds: Bonds are long-term promissory notes that are represented by a company while borrowing money from investors to raise fund for financing the operations.
Bonds Payable: Bonds payable are referred to long-term debts of the business, issued to various lenders known as bondholders, generally in multiples of $1,000 per bond, to raise fund for financing the operations.
Premium on bonds payable: It occurs when the bonds are issued at a higherprice than the face value.
Effective-interest amortization method: Effective-interest amortization methodit is an amortization model that apportions the amount of bond discount or premium based on the market interest rate.
Prepare journal entry for cash proceeds from the issuance of the bonds on January 1, 2015.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
January 1, 2015 | Cash | 102,070 | |||||
Premium on Bonds Payable | 2,070 | ||||||
Bonds Payable | 100,000 | ||||||
(To record issuance of bonds payable at discount) |
Table (2)
- Cash is an asset and it is increased. So, debit it by $102,070.
- Premium on Bonds Payable is an adjunct liability account and itis increased. So, creditit by $2,070.
- Bonds payable is a liability and it is increased. So, credit it by $100,000.
Working note:
Calculate premium on bonds payable.
3.
To prepare: Journal entry to record the interest payment on December 31, 2015.
Explanation of Solution
Prepare journal entry for payment of interest and amortization of premium on bonds.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
December 31, 2015 | Interest Expense | 4,338 | |||||
Premium on Bonds Payable | 662 | ||||||
Cash | 5,000 | ||||||
(To record payment of interest and amortization of premium on bonds) |
Table (3)
- Interest expense is an expense and it decreases the equity value. So, debit it by $4,338.
- Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $662.
- Cash is an asset and it is decreased. So, credit it by $5,000.
Working notes:
Calculate cash interest payment.
Calculate interest expense.
Calculate premium amortized.
To prepare: Journal entry to record the interest payment on December 31, 2016.
Explanation of Solution
Prepare journal entry for payment of interest and amortization of premium on bonds.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
December 31, 2016 | Interest Expense | 4,310 | |||||
Premium on Bonds Payable | 690 | ||||||
Cash | 5,000 | ||||||
(To record payment of interest and amortization of premium on bonds) |
Table (3)
- Interest expense is an expense and it decreases the equity value. So, debit it by $4,310.
- Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $690.
- Cash is an asset and it is decreased. So, credit it by $5,000.
Working notes:
Calculate cash interest payment.
Calculate interest expense.
Calculate premium amortized.
4.
To prepare: Journal entry to record the interest and face value payment on December 31, 2017.
Explanation of Solution
Prepare journal entry for payment of interest and face value.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
December 31, 2017 | Interest Expense | 4,282 | |||||
Bonds Payable | 100,000 | ||||||
Premium on Bonds Payable | 718 | ||||||
Cash | 105,000 | ||||||
(To record payment of interest and face value) |
Table (3)
- Interest expense is an expense and it decreases the equity value. So, debit it by $4,282.
- Bonds payable is a liability and it is decreased. So, debit it by $100,000.
- Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $718.
- Cash is an asset and it is decreased. So, credit it by $105,000.
Working notes:
Calculate cash interest payment.
Calculate interest expense.
Calculate premium amortized.
5.
To prepare: Journal entry to record the bond retirement on January 1, 2017.
Explanation of Solution
Retirement of Bonds: The process of repaying the sale amount of bonds to bondholders at the time of maturity or before the maturity period is called as retirement of bonds. It is otherwise called as redemption of bonds.
Prepare Journal entry to record the bond retirement on January 1, 2017.
Date | Account Title and Explanation | Post Ref | Debit ($) | Credit ($) | |||
January 1, 2017 | Bonds Payable | 100,000 | |||||
Premium on Bonds Payable | 718 | ||||||
Loss on Retirement of Bonds | 282 | ||||||
Cash | 101,000 | ||||||
(To record the retirement of the bonds) |
- Bonds payable is a liability and it is decreased. So, debit it by $100,000.
- Premium on Bonds Payable is an adjunct liability account and itis decreased. So, debitit by $718.
- Loss on retirement of bonds is an equity account and it is decreased. So, debit it by $282.
- Cash is an asset and it is decreased. So, credit it by $101,000
Working note:
Determine the gain or loss on the retirement of the bonds.
Step 1: Calculate carrying amount of bonds payable on the retirement.
Step 2: Compute loss on the redemption of the bonds payable.
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