On January 1 of Year 1, Drum Line Airways issued $2,500,000 of par value bonds f

Question

On January 1 of Year 1, Drum Line Airways issued $2,500,000 of par value bonds for $2,280,000. The bonds pay interest semiannually on January 1 and July 1. The contract rate of interest is 7% while the market rate of interest for similar bonds is 8%. The bond premium or discount is being amortized at a rate of $7,333 every six months. The company's December 31, Year 1 balance sheet should reflect total liabilities associated with the bond issue in the amount of: $2,792,834. $2,207,166. $2,294,666. $2,705,334. $2,382,166.

Explanation / Answer

On January 1 of Year 1, Drum Line Airways issued $3,500,000 of par value bonds for $3,200,000. The bonds pay interest semiannually on January 1 and July 1. The contract rate of interest is 7% while the market rate of interest for similar bonds is 8%. The bond premium or discount is being amortized at a rate of $10,000 every six months. When the bonds were issued, Dr Cash $3,200,000 (actual amt rec'd) Dr Bonds discount $300,000 Cr Bonds payable $3,500,000 (always par value) On July 1 (assuming bonds interest had not been accrued before): Dr Interest expense $112,500 Cr Bonds discount $10,000 Cr Cash $122,500 ($3.5m x 7% x 6/12) On Dec 31, when Drum Line has to close its books: Dr Interest expense $112,500 Cr Bonds discount $10,000 Cr Interest payable $122,500 After the above entry, on Dec 31, the balance in the Bonds discount account = $300,000 - $10,000 - $10,000 = $280,000. Book value of a bond = Face value - Unamortized discount = $3,500,000 - $280,000 = $3,220,000 The company's December 31, Year 1 balance sheet should reflect total liabilities associated with the bond issue in the amount of: ? Total liabs = book value of the bonds + interest payable = $3,220,000 plus interest payable of $122,500.

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