Wilbury Corporation issued $1 million of 13.5% bonds for $985,071.68. The bonds

Question

Wilbury Corporation issued $1 million of 13.5% bonds for $985,071.68. The bonds are dated and issued October 1, 2016, are due September 30, 2020, and pay interest semiannually on March 31 and September 30. Assume an effective yield rate of 14%

Required:

1. Prepare a bond interest expense and discount amortization schedule using the straight-line method.

2. Prepare a bond interest expense and discount amortization schedule using the effective interest method.

3. Prepare adjusting entries for the end of the fiscal year December 31, 2016, using the: a. straight-line method of amortization b. effective interest method of amortization

4. If income before interest and income taxes of 30% in 2017 is $500,000, compute net income under each alternative.

5. Assume the company retired the bonds on June 30, 2017, at 98 plus accrued interest. Prepare the journal entries to record the bond retirement using the: a. straight-line method of amortization b. effective interest method of amortization

6. Compute the company’s times interest earned (pretax operating income divided by interest expense) for 2017 under each alternative.

Explanation / Answer

1)

In straight line method, any discount allowed for issuance of bonds will be amortized in equal installments in every interest period.

2)

Bond interest exp and amortizaton schedule under effective interest method

3)

a)

Adjusting entries for the end of the fiscal year December 31,2016 under straight line method of Amortization

Interest Expense Dr ($33750+933.02)

To Discount on bonds ($1866.04x3)/6

To Interest payable ($67500x3)/6

(Being interst payable)

933.02

33750

b)

Journal entries under Effective Interest method of amortization

Interest Expense dr

To Discount on bonds

To Interst Payable

(Being Interest Payable)

727.51

33750

4)

Interest under Straight line method for the period 01/01/2017 to 31/12/2017

Interest = $69366.04 x 2 = $138732.08

Interst Under Effective interest method for the period 01/01/2017 to 31/12/2017 :

Interest from 01/01/2017 to 31/3/2017 ($68955.02-$34683.02) = $34272

Interest from 01/04/2017 to 30/09/2017 is $69056.87

Interest from 1/10/2017 to 31/12/2017 ($988083.57x14%)x3/12 = $34582.92

Interes for the period is t01/01/2017 to 31/12/2017 =$34272 +$69056.87+$34582.92

=$137911.79

now Net income for 2017 under each alternative

5)

a)

If redemption is betweenInterst payment dates , we have to pass journal entries for interest and discount from date of previous interest payment to the date of redemption.

Journal entries for march 31,2017 to June 30,2017

To interest Payable

( being Interest Payable)

Calculation of carrying value of bonds :

Book value of bonds on March 31 2017 is $986937.72

discount amortized from march to june is $933.02

Carrying value of bonds on 30/06/2017 = $986937.72+$933.02= $987870.74

Gain / loss from Redemption = Carrying Value - call price without interest

= $987870.74 - $980000 = $7870.74

Journal entries for redemption of bonds

To cash/bank ($980000+$33750)

(being bond redeemed)

b) Effective Interest method of amortization

To interest payable $67500x3/6

(Being Interest payable)

Carrying value of bonds = book value of bonds on 31st march 2017 + discount amortized for march 31 to june 30 2017

= $986526.70+$778.43 = $987305.13

Gain/loss from redemption of bonds = $987305.13 - $980000 = $7305.13

Journal Entries

To cash/bank

(being bonds redeemed)

6)

Time Interest Earned ratio = pretax operating income/interest expense

straight line method : $500000/$138732.08 = $3.60

Effective interest method : $500000/$137911.79=$3.63

Date Payment of interest (a) ($) Amortized discount (b) $ Interest expense (c) $ Book value(d) $ ($1000000x13.5%)/2 ($14,928.32) / 8 (a+b) (b+d) 01/10/2016 985071.68 31/03/2017 67500 1866.04 69366.04 986937.75 30/09/2017 67500 1866.04 69366.04 988803.76 31/03/2018 67500 1866.04 69366.04 990669.80 30/09/2018 67500 1866.04 69366.04 992535.84 31/03/2019 67500 1866.04 69366.04 994401.88 30/09/2019 67500 1866.04 69366.04 996267.92 31/03/2020 67500 1866.04 69366.04 998133.96 30/09/2020 67500 1866.04 69366.04 1000000

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