Hello, I sent the below to you but the response seems wrong as they do to take i
ID: 2472723 • Letter: H
Question
Hello, I sent the below to you but the response seems wrong as they do to take into account important info such as the market rate (therefore do not calculate present value) and do not use effective interest amortization. I need this to be very clear and 100% correct:
On January 1, 2014, Park Corporation sold a $600,000, 7.5 percent bond issue (8.5 percent market rate). The bonds were dated January 1, 2014, pay interest each June 30 and December 31, and mature in four years.
Required:
1) Give the journal entry to record the issuance of the bonds.
2) Give the journal entry to record the interest payment on June 30, 2014. Use effective-interest amortization.
3) Show how the bond interest expense and the bonds payable should be reported on the June 30, 2014, income statement and balance sheet.
The below is what i got as an answer but is seems wrong and IT IS NOT CLEAR AT ALL FOR ME:
Journal Entries
1-Jan-14
Cash/Bank A/c Dr 600000
7.5% Bonds Cr 600000 (Bonds issued to public)
30-Jun-14
P&L A/c Dr 22500
Interest on 7.5% Bonds Cr 22500 (Interest due at half yearly rest)
Interest on 7.5% Bonds Dr 22500
Cash A/c Cr 22500 (Interest paid at half yearly rest)
3) As assesed from journal entries too, Interest expense are to be recognised in Income Statement at Debit side. 7.5% Bonds are shown at Liabilities side of Balance Sheet THIS IS NOT CLEAR
Explanation / Answer
Hi,
First of all, Journal entry for (1) is incorrect. $600,000 is the bond's face value, but since bond interest rate & market interest rate are different, the Sale Price received from the bond will not be equal to face value.
Price (P) of a bond is sum of present value (PV) of its future cash flows, so
Price = PV of future coupon interests + PV of redemption price (face value)
Semi-annual coupon rate = 7.5% / 2 = 3.75%
Semi-annual coupon payment = $600,000 x 3.75% = $22,500
Semi-annual market rate = 8% / 2 = 4%
Number of coupon periods = 4 x 2 = 8
Bond price ($) = 22,500 x PVIFA(4%, 8) + 600,000 x PVIF(8%, 4)**
[**Since the face value will be re-paid after 4 years & there is no semi-annual compoundings, we can use the annual rates & number of years, instead of semi-annual rate & number of half-years]
= 22,500 x 6.7327 [From PVIFA table] + 600,000 x 0.7350 [From PVIF table]
= 151,485.75 + 441,000
= 592,485.75
This is the amount for which the bond was sold at issue (and is the Book value of bond on 1 Jan 2014). Since face value is $600,000, the bond was sold at a Discount of $(600,000 - 592,485.75) = $7,514.25.
So,
(1) Journal entry at issue:
DR Cash $592,485.75
DR Discount on bond $7,514.25
Bonds payable $600,000
(To record bond issued at discount)
(2) There are 2 sets of journal entries for Interest payment on 30 June. This is also incorrect and only one entry is sufficient:
DR Interest payment on bond $22,500
Cash $22,500
(To record semi-annual interest paid on bond)
**Note that question is asking to entry "Interest payment" and not "Interest expense". Interest Payment is the semi-annual coupon rate based on 3.75% coupon rate. But if Interest Expense was to be recorded, we had to entry on basis of 4% market interest rate. In this case, that is not necessary.
(3) Here, Interest payment & interest expense both come into the picture. In the Income statement, Bond Interest Payment is recorded as $22,500 (coupon payment).
However, Interest Expense = 4% x Book Value on 1 Jan 2014 = 4% x $592,485.75 = $23,699.43
Amortization of bond discount = Interest Expense - Interest payment = $(23,699.43 - 22,500) = $1,199.43
Balance in bond discount, 30 June 2014 = Balance in bond discount, 1 Jan 2014 - Amortization of Discount
= $(7,514.25 - 1,199.43) = $6,314.82
Book value of bond on 30 Jan = Book value on 1 Jan 2014 - Balance in Bond discount on 30 June 2014
= $(592,485.75 - 6,314.82) = $586,170.93
Therefore, In Balance sheet, the book value of Bond is shown as $586,170.93.
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