1. Grant Inc. issued $400,000 of 6% bonds on June 30, 2016. The bonds mature in
ID: 2539954 • Letter: 1
Question
1. Grant Inc. issued $400,000 of 6% bonds on June 30, 2016. The bonds mature in 10 years. For bonds of similar risk and maturity, the market interest rate is 4%. Interest is paid semiannually on December 31 and June 30. (i.e., the first interest payment will be made on December 31, 2016). For all computations, ignore below decimal point.
a) Determine whether the company sold the bond at discount or premium
b) Determine the price of the bonds at June 30, 2016 and prepare the journal entry to record the issuance of the bonds.
c) Prepare the journal entry to record interest on December 31, 2016 by using effective interest method
d) Prepare the journal entry to record interest on June 30, 2017 by using effective interest method
e) Grant Inc. did not hold the bond to maturity and retired the bond on July 1, 2017, at 105 (i.e., 105% of face value). Prepare the journal entry to record the extinguishment of the bonds on July 1, 2017. Ignore one-day interest between June 30 and July 1. In other words, the carrying value of the bonds as of June 30, 2017 (computed in question d) should be eliminated by the extinguishment of the bonds on July 1, 2017.
Explanation / Answer
Solution:
Part a & b
Determine the price of the bonds issued on June 30, 2016
It is given in the question that bonds of similar risk and maturity, the market interest rate is 4%. It means the Market Rate of Return on the bonds is 4%. So we need to calculate the Price of the bonds issued by using the market yield 4%.
Primary Working
Par Value = $400,000
Semi Annual Coupon Interest = Par Value 400,000* Coupon Rate 6% * 1/2 Half Yearly = $12,000
Semiannual period to maturity (n) = 10 years x 2 = 20
Semi Annual Market Interest Rate (R) = 4%*1/2 = 2%
Present Value of Bonds (Price of the bonds issued) = Semi Annual Coupon Interest x PVIFA (R,n) + Par Value x PVIF (R,n)
= (12,000*16.35143) + (400,000*0.67297)
= $196,217 + $269,188
= $465,405
Note -- Calculation of Present Value Factor (Rounded to 5 decimal places)
PVIFA (R, n) = Present Value interest factor for ordinary annuity at R% for n periods = (1 – 1/(1+R)n) / R
PVIFA (2%,20) = (1 – 1/(1+0.02)20) / 0.02 = 16.35143
PVIF (R, n) = Present Value interest factor for ‘n’ period at ‘R’% = 1/(1+R)n
PVIF (2%, 20) = 1/(1+0.02)20= 0.67297
The Issue Price of the bonds = $465,405
a) Issue price of the bonds are higher than the face value of the bonds, it means the bonds are issued at premium.
b) Price of the bonds at June 30, 2016 = $465,405
Journal Entry
Date
General Journal
Debit
Credit
June.30, 2016
Cash
$465,405
Bonds Payable
$400,000
Premium on Bonds Payable (bal fig)
$65,405
To answer the Part c, d and e – we need to prepare an Amortization Table for Bond Premium till June 30, 2017
Schedule of Amortization of Bond PREMIUM (Effective Rate Method)
Payment intervals
Date
Cash Paid (Face Value of the Bonds $400,000 x Coupon Rate 6% * 1/2 half yearly)
Interest Expense (Carrying Value at the beginning of period x Market Interest Rate 4% * 1/2 Half Yearly)
Premium Amortization (Cash Paid - Interest Expense)
Carrying Amount of Bonds
0
June.30, 2016
$465,405
1
Dec.31, 2016
$12,000
$9,308
$2,692
$462,713
2
June.30, 2017
$12,000
$9,254
$2,746
$459,967
Part c -- journal entry to record interest on December 31, 2016 by using effective interest method
Date
General Journal
Debit
Credit
Dec.31, 2016
Interest Expense
$9,308
Premium on Bonds Payable (Amortization)
$2,692
Interest Payable
$12,000
Part d-- journal entry to record interest on June 30, 2017 by using effective interest method
Date
General Journal
Debit
Credit
June.30, 2017
Interest Expense
$9,254
Premium on Bonds Payable (Amortization)
$2,746
Interest Payable
$12,000
Part e – Extinguishment of the bonds
Carrying Value of the bonds on July 1, 2017 = $459,967
It includes unamortized premium = $59,967 and face value $400,000
Extinguishment Value of the bonds = Face Value x 105% = $400,000 * 105% = $420,000
Carrying Value is higher than Extinguishment Value, it means the company is paying less amount to extinguish the bonds. Hence company will record a gain on extinguishment of the bonds.
Date
General Journal
Debit
Credit
July.1, 2017
Bonds Payable
$400,000
Premium on Bonds Payable (Unamortized Portion)
$59,967
Cash (paid for extinguishment of the bonds)
$420,000
Gain on Retirement of the bonds (Bal fig)
$39,967
Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you
Date
General Journal
Debit
Credit
June.30, 2016
Cash
$465,405
Bonds Payable
$400,000
Premium on Bonds Payable (bal fig)
$65,405
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