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Question
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Can you help me the answer? This is what I have to far on question 1 and 2
1. the 8% bond issued when the market interest is 7.25% will be at a Preminum. They are attractive in this market, so investor will pay more than maturity value to acquire them
2. the 8% bond issued when the market interest is 7.25% will be at a Discount. They are unattractive in this market, so investor will pay less than maturity value to acquire them
Explanation / Answer
1) The bonds will be priced at a premium because the market rate of interest is less than the interest offered by the bonds. Since the bonds will be paying investors more than the interest required by the market ($900000 x 8% x 10 = $720000 against $900000x7.25%x10 = $652500), the investors will pay more than $900000 for the bonds.
2) If the market rate of interest is 9.5% against the stated rate of interest 8% by the bond, the bonds will be sold at a discount. Since the investors will be paying less interest ($720000) to the investors than the interest ($900000 x 9.5% x 10 = $855000) that is offered by the market over the life of the bonds, the company issuing the bonds will have to compensate the investors for the loss in interest and consequently will issue the bonds at a discounted price.
Premium on bonds payable = $924000 - $900000 = $24000
Semi-annual Amortization of premium (by straight line method) = 24000 / 20 = $1200
a)
March 1 2014
Cash......................................Dr. $924000
Premium on Bonds Payable....................Cr. $24000
Bonds payable........................................Cr. $900000
b)
August 31, 2014
Interest expense........................Dr. 34800
Premium on Bonds Payable......Dr. $1200
Cash..........................................................Cr. $36000
c)
Sept 30, 2014
Interest expense........................Dr. 5800
Premium on Bonds Payable......Dr. $200
Interest payable..........................................................Cr. $6000
d)
Interest expense........................Dr. 34800
Premium on Bonds Payable......Dr. $1200
Cash..........................................................Cr. $36000
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