On August 1, 2012, Randall Jackson Co. sells $4,000,000 of 10% bonds dated June

Question

On August 1, 2012, Randall Jackson Co. sells $4,000,000 of 10% bonds dated June 1, 2012 for 93.7902. The bonds yield 12%. Legal and other costs of $32,000 were incurred in connection with the issue. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2016. The bonds are callable at 102. On October 1, 2013, RJ Co. buys back $1,200,000 worth of the bonds. The bond issue cost are being deferred and amortized on a straight-line basis over the life of the bond. The discount on the bond is also being amortized on a straight-line basis over the life of the bond. (Straight-line is not materially different in effect from the preferable effective interest method). Required: a) Prepare all necessary and appropriate journal entries on the following dates: 1. August 1, 2012 2. December 1, 2012 3. December 31, 2012 4. June 1, 2013 5. October 1, 2013 6. December 1, 2013

Explanation / Answer

On 1Aug'12, Cash Rxd = 0.937902*$4,000,000 = $3,751,608 & Dicount on Bond = $4,000,000- $3,751,608 = $248,392 So Journal entry will be : 1 Aug'12 Cash Dr $3,751,608 Discount on Bonds Payable Dr $248,392 Bonds Payable Cr $4,000,000 Issue bonds at a discount (b) The total interest expense can be calculated using the bond-related payments and receipts as shown: Repayments Principal $4,000,000 Interest (10%*4,000,000*6/12 times 8 semiannual periods) $1,600,000 Total cash payments to investors $5,600,000 Less: Cash receipts from investors ( $3,751,608) So Total interest expense 1,848,392 The straight-line method of allocating the discount to interest expense spreads the $248,392 of discount evenly over the 8 semiannual interest payments made for the bonds. 1 June'12 Interest Expense Dr $231,049 Discount on Bonds Payable ($248,392/8 period) Cr $31,049 Cash ($4,000,000*10% *6/12) Cr $200,000 Pay semiannual interest using straight-line amortization 31 Dec'12 Interest Expense Dr $231,049 Discount on Bonds Payable ($248,392/8 period) Cr $31,049 Cash ($4,000,000*10% *6/12) Cr $200,000 Pay semiannual interest using straight-line amortization 1 June'13 Interest Expense Dr $231,049 Discount on Bonds Payable ($248,392/8 period) Cr $31,049 Cash ($4,000,000*10% *6/12) Cr $200,000 Pay semiannual interest using straight-line amortization On 1 Oct'13 : Cash Paid = 1.02*$1,200,000 = 1,224,000 Carrying value of Bond = Ending Bnd Value as on 1 Jun13*(1,200,000/4,000,000) = 3,813,706*(12/40) = 1,144,112 So Loss on Calling Bond = 1224,000 - 1144,112 = 79,888 But also in expenses you have to include part of the $32,000 legal costs, pro-rated for the portion retired (1 Yr 4M), and amortized (that means decreased) (because the Call was in 1Yr 4Month (=16month), Total period was 4 Yrs (48 mon) of the bond) So part of the loss is the unamortized part of legal cost: $ 32,000 x (12/40) x (16/48) = $3,200 1 Oct13 Bond Payable Dr 1,200,000 Loss on Calling Bond Dr 24,000 Cash Paid Cr1,224,000 1 Oct'13 Interest Expense Dr $58,112 Discount on Bonds Payable (217343/8)*(4/6) period) Cr18,112 Cash ($1,200,000*10% *6/12*4/6) Cr $40,000 Pay interest using straight-line amortization 1 Dec 13 Interest Expense Dr $158,112 Discount on Bonds Payable ($248,392/8 period) Cr $18,112 Cash ($2,800,000*10% *6/12) Cr $140,000 Pay semiannual interest using straight-line amortization

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