On January 1, 2014, Cron Corporation issued $740,000 in bonds that mature in ten
ID: 2331815 • Letter: O
Question
On January 1, 2014, Cron Corporation issued $740,000 in bonds that mature in ten years. The bonds have a stated interest rate of 12 percent and pay interest on June 30 and December 31 each year. When the bonds were sold, the market rate of interest was 10 percent. The company uses the effective-interest amortization method. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use the appropriate factor(s) from the tables provided.)
What was the issue price on January 1, 2014?
What amount of interest expense should be recorded on (a) June 30, 2014? and (b) December 31, 2014?
What amount of cash interest should be paid on (a) June 30, 2014? and (b) December 31, 2014?
What is the book value of the bonds on (a) June 30, 2014? and (b) December 31, 2014?
On January 1, 2014, Cron Corporation issued $740,000 in bonds that mature in ten years. The bonds have a stated interest rate of 12 percent and pay interest on June 30 and December 31 each year. When the bonds were sold, the market rate of interest was 10 percent. The company uses the effective-interest amortization method. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use the appropriate factor(s) from the tables provided.)
Explanation / Answer
Cron Corporation
Issue price = PV of bonds + PV of the annuity (semi-annual interest payments) over 20 periods at market rate of 5%.
PV bonds = PV $740,000 (P/F, 20, 5%)
PV of bonds = $740,000 x 0.3769 = $278,906
Semiannual interest = $740,000 x ½ x 12% = $44,400
PV of annuity of semi-annual interest payments = $44,400 (P/A, 20, 5%)
PV of annuity of semi-annual interest payments = $44,400 x 12.462 = $553, 313
Total issue price = $278,906 + $553,313 = $832,219
Total issues price = $832,219
Less: face value = $740,000
Premium on bond = $92, 219
Using effective interest rate amortization method to amortize $92,219 over 20 periods, the Interest Expense for 6 months would be 5% (10% x1/2) of the carrying value of the bond.
Carrying value = $832,219
Interest Expense as on June 30, 2014 would be = $832,219 x 5% = $41,611
Interest Paid = $44,400
Premium amortized = $44,400 - $41,611 = $2,789
Premium amortization = $2,789
Reduction in Premium on bond = $92,219 - $2,789 = $89,430
Carrying value of bond = $832,219 - $2,789 = $829,430
Interest Expense as on December 31, 2014 = $829,430 x 5% = $41,472
Interest Paid = $44,400
Premium amortized = $44,400 - $41,472 = $2,928
Semi-annual Cash interest to be paid = face value of the bond x stated interest rate x ½
= $740,000 x 12% x ½ = $44,400
Semi-annual cash interest to be p aid = face value of the bond x stated interest rate x ½
= $740,000 x 12% x ½ = $44,400
Book value of bonds = total issue price – premium amortized
Total issue price = $832,219
Premium amortized = cash interest paid – interest expense
= $44,400 - $41,611 = $2,789
Premium amortized = $2,789
Book value = $832,219 - $2,789 = $829,430
Book value of bonds = book value as on June 30, 2014 – premium amortized
Book value as on June 30, 2014 = $829,430
Premium amortized = Cash interest paid – interest expense
= $44,400 - $41,472 = $2,928
Book value as on Dec 31, 2014 = 829,430 - $2,928 = $826,502
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