On March 1, 2012, Mechanics Credit Union (MCU) issued 7%, 20-year bonds payable

Question

On March 1, 2012, Mechanics Credit Union (MCU) issued 7%, 20-year bonds payable with maturity value of $300,000. The bonds pay interest on February 28 and August 31. MCU amortizes bond premium and discount by the straight-line method.

Requirements
1. If the market interest rate is 6% when MCU issues its bonds, will the bonds be priced at maturity (par) value, at a premium, or at a discount? Explain.

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

3. The issue price of the bonds is 95. Journalize the following bond transactions:
(a) Issuance of the bonds on March 1, 2012
(b) Payment of interest and amortization of discount on August 31, 2012
(c) Accrual of interest and amortization of discount on December 31, 2012
(d) Payment of interest and amortization of discount on February 28, 2013

Explanation / Answer

1. Semiannual payment =$300,000*7%/2 =$10500 Price of the bond = 10500/1.03 + 10500/1.03^2 + 10500/1.03^3 .................10500/1.03^40 + $300,000/1.03^40 Price of the bond =$329,400.66 Price of the bond is greater than par value The bond will be priced at a premium 2. If the market interest rate is 8% Price of the bond = 10500/1.04 + 10500/1.04^2 + 10500/1.04^3 .................10500/1.04^40 + $300,000/1.04^40 Price of the bond =$274,061.95 Price of the bond is less than par value The bond will be priced at a discount

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