2. Prepare the journal entries by both firms to record all subsequent brad event

Question

2. Prepare the journal entries by both firms to record all subsequent brad events related to the bonds through maturity. 14-7 McWherter Instruments sold $400 million of 8% bonds, dated January 1, on January 1, 2016. The bonds mature on December 31, 2035 (20 years) For bonds of similar risk and maturity, the market yield was 10%. Interest is paid semiannually on June 30 and December 31. Blanton Technologies, Inc., purchased $400,000 of the bonds as a long-term investment. Issuer and investor effective interest LO14-2 Required: 1. Determine the price of the bonds issued on January 1, 2016. 2. Prepare the journal entries to record (a) their issuance by McWherter and (b) Blanton's investment on January 1, 2016. 3. Prepare the journal entries by (a) McWherter and (b) Blanton to record interest on June 30, 2016 (at the effective rate). 4. Prepare the journal entries by (a) McWherter and (b) Blanton to record interest on December 31, 2016 (at the effective rate). The fiscal year ends December 31 for Lake Hamilton Development. To provide funding for its Moonlight Bay project, LHD issued 5% bonds with a P 14-8 Bonds; effective interest; partial period interest financial statement effects face amount of $500,000 on November 1, 2016. The bonds sold for $442,215, a price to yield the market rate of 6%. The bonds mature October 31, 2036 (20 years). Interest is paid semiannually on April 30 and October 31. LO14-2 Required: 1. What amount of interest expense related to the bonds will LHD report in its income statement for the year ending December 31, 2016? 2. What amount(s) related to the bonds will LHD report in its balance sheet at December 31 20162

Explanation / Answer

We will calculate the PV of coupons using the present value of annuity formula i.e CF x [1 - (1 + r)^-n] / r

We will calculate the PV of par value expected to be received on maturity using present value formula i.e CF / (1 + r)^n

Assuming par value of bond as $100

Price of bond = 4% x 100 x [1 - (1 + 0.05)^-40] / 0.05 + 100 / (1 + 0.05)^40

= 4 x [1 - 0.14204] / 0.05 + 100 / 7.03998

= 4 x 17.15909 + 14.20457

= 82.8409 i.e $82.84

Journal Entries in the books of McWherter Instruments

Notes:

Interest expenses in case of bonds issued at discount has two components; one is payment on intrest based on the copun rate and the second is the amortisation of discount. In this case discount is amortised using the effective interest rate

The effective interest rate is the market interest rate on the date that the bonds were issued. In our example the market interest rate on January 1, 2016 was 5% per semiannual period for 40 semiannual periods.

Interest expense to be paid semi annually = 8% x 6/12 x 400 = $16 million

The effective interest rate is multiplied times the bond's book value at the start of the accounting period to arrive at each period's interest expense.

The difference between Interest expense and Effective interest is the amount of amortization.

The following table shows the calculation

Journal Entries in the books of Blanton Technologies

The following table shows calcuation of discount amortisation

Date Particulars Amount
(in millions) Amount
(in millions) Jan 1, 2016 Cash 331.36 Discount on Bonds Payable 68.64 Bonds Payable 400.00 (Being 4 million , 8% semi annual coupon bonds having par value of $100 issued at a discounted value of $82.84) June 30, 2016 Interest expense 16.57 Interest payable 16.00 Discount on Bonds Payable 0.57 (Being semi annual interest paid and discount on bonds issued amortised) Dec 31, 2016 Interest expense 16.60 Interest payable 16.00 Discount on Bonds Payable 0.60 (Being semi annual interest paid and discount on bonds issued amortised)

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