On January 1, 2013, Cool Universe issued 10% bonds dated January 1, 2013, with a
ID: 2354455 • Letter: O
Question
On January 1, 2013, Cool Universe issued 10% bonds dated January 1, 2013, with a face amount of $20 million. The bonds mature in 2022 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31. Required: (50 points) 1. Determine the price of the bonds at January 1, 2013. 2. Prepare the journal entry to record the bond issuance by Cool on January 1, 2013. 3. Prepare the journal entry to record interest on June 30, 2013, using the straight-line method. 4. Prepare the journal entry to record interest on December 31, 2013, using the straight-line method.Explanation / Answer
Well, to determine the price of the bond on initial sale, we have to do a present value calculation. The face is for $20 million, and interest needs to still be found. The bond is issued at 10%, but remember this 10% is always representative of the annual interest, and since the payments are semi-annual, that would mean interest rate for calculations is 5% or $1 million dollars per period for 20 periods, 10 years to maturity*2 since payments are twice a year. Now that we know the periods the present value calculations need to be completed. Present value is found using the market yield percentage, or 6%, 12%/2, for 20 periods, 10*2 once again, since this yield is also semi-annual. So the present value of $20 million to be received at the end of 20 periods with a 6% market interest rate, here I will use the present value tables you should have access to, if not I will show you the mathematical steps for computing present value factor at the very bottom of this answer. So the coefficient for 20 periods with 6% market interest rate is 0.312, so the present value is $20 million*0.312 or $6,240,000. That is the computation of the face value. Now the second component of any bond value is the interest rate. Interest rate for this bond as shown above is $1 million dollars every period for 20 periods. To find the present value of $1 million dollars received every period we use our ordinary annuity table, the coefficient at 6% for 20 periods is 11.470, so the present value of the interest is $11,470,000. Thus the total value of the bond is face + interest or $6,240,000 + $11,470,000=$17,710,000, which is the price of the bonds at this time. 2. Thus, the journal entry would be: Cash (Debit): 17,710,000 Unamortized Bond Discount (Debit): 2,290,000 Bonds Payable (Credit): 20,000,000. This makes sense. since the face interest rate is less than the market interest rate, the bonds will be issued at a discount, vice-versa the bonds will be issued at a premium. You will have a note underneath the entry stating Sold 10 year semi-annual, 10% debentures, due January 1, 2022. When you have an entry on your balance sheet or in the journal for bonds you always disclose in the notes the time period, the face interest rate, and the maturity date. C. To record interest under the straight line method, first compute total interest payments=10*2=20. Next we amortize the bond discounts per period=2,290,000/20=114,500. The next step is to find the cash interest payment from the face. We computed this earllier, but once again you take face value times interest times number of period or $20 mil * 0.05 * 20=$20 million. You then divide the total interest by 20 to get the interest per period which, as found above, is $1 million. Thus the final interest expense per period is interest + discount or 1,114,500. So journal entry on June 20, 2013 is Bond interest expense (debit) 1,114,500 Unamortized Bond discount (Credit) 114,500 Cash (Credit) 1,000,000. The journal entry on December 31, 2013 is the exact same under the straight-line method, however the entry can have a credit for interest payable instead of the cash entry at the same value if it signifies the company has not paid yet, if no information is on this in the problem it is assumed they pay the interest when it is due and cash would be used. To find the present value factor for a single sum due in 20 periods at 6% take (1+i)^n so you get (1/(1+0.06)^20=0.312 (rounded) You then take this 0.312* the future value to get the present value. To find the present value factor of an ordinary annuity for 20 periods at 6* you take (1-(1/(1+i)^n))/i or (1-(1/(1+0.06)^20))/0.06=11.470 (rounded) you then take this time the value paid as an ordinary annuity, in this case 1,000,000
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