On January 2, 2010, the T Financial Corporation sold a large issue of Series A $
ID: 2732949 • Letter: O
Question
On January 2, 2010, the T Financial Corporation sold a large issue of Series A $1,000 denomination bonds. The bonds had a stated coupon rate of 6% (annual), had a term to maturity of four years, and made annual coupon payments (on December 31). Market conditions at the time were such that the bonds were sold at their face value. During the ensuing two years, market interest rates fluctuated widely, and by January 2, 2012, the T Financial bonds were trading at a price that provided an annual yield of 10%. T Financial's management was considering purchasing the Series A bonds in the open market and retiring them; the necessary capital was to be raised by a new bond issue-the Series B bonds. Series B bonds were to be $1,000 denomination coupon bonds with a stated coupon rate of 8% (annual), making annual coupon payments (on December 31), and a three year term Management felt that these bonds could be sold at a price yielding no more than 10%, especially if the Series A bonds were retired.Explanation / Answer
First we need to find market price of bond on Jan 2, 2012
Coupon Payment = 1000*6% = 60
Yield = 10%
Current Market price = Coupon payment/Yield
= 60/10% = 600
Journal Entry for purchase and retirement
Date
Particulars
Debit
Credit
Jan,2, 2012
Bond
600
Cash
600
(For purchase of bonds in open market)
Bonds Payable
1000
Gain on bond retirement
400
Bonds
600
(For retirement of bonds)
Issue of Series B bond price
Issue price = Coupon payment/Yield
= 80/10% = 800
Date
Particulars
Debit
Credit
Jan,2, 2012
Cash
800
Discount on bonds payable
200
Bonds payable
1000
(For Issue of Series B bonds at discount of 200)
Interest Expense
146.67
Discount on bonds payable
66.67
Interest payable or Cash
80
(For recording of interest expense on bonds)
Note: Discount to be amortized 200/3 = 66.67 per year
Date
Particulars
Debit
Credit
Jan,2, 2012
Bond
600
Cash
600
(For purchase of bonds in open market)
Bonds Payable
1000
Gain on bond retirement
400
Bonds
600
(For retirement of bonds)
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