On January 1, 2011, Club Company issued 10% bonds, dated January 1, 2011, with f

Question

On January 1, 2011, Club Company issued 10% bonds, dated January 1, 2011, with face amount of $20 million. The bonds matue in 2020 (10 years). For bonds of similar risk and maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.

Requred:

1. Determine the price of teh bonds at January 1, 2011.

2. Prepare the journal entry to record the bond issuance by Club on January 1, 2011.

3. Prepare the journal entry to record interest on June 30, 2011, using the straight-line method.

4. Prepare the journal entry to record interest on December 31, 2011 using the straight-line method.

5. Prepare the journal entry to record interest on June 30, 2011, using the effective interest method.

6. Prepare the journal entry to record intrest on December 31, 2011, using the effective interest method.

Explanation / Answer

(1) You first have to calculate the net present value of the face value of the bonds ($80,000,000) plus the semi-annual interest payments ($4,000,000), using the market rate of 6%. The NPV is $70,824,063. Dr Securities 70,824,063 Cr Cash 70,824,063 (2) The cash received will always be the same ($4,000,000) but you also have to amortize the discount to calculate the full amount of the interest revenue. 70,824,063 x 6% = 4,249,444 interest revenue 4,249,444 - 4,000,000 = 249,444 bond discount amortization Dr Cash 4,000,000 Dr Securities 249,444 Cr Interest Revenue 4,249,444 The carrying value of the bonds is now 70,824,063 + 249,444 = $71,073,507 (3) 71,073,507 x 6% = 4,264,410 interest revenue 4,264,410 - 4,000,000 = 264,410 bond discount amortization Dr Cash 4,000,000 Dr Securities 264,410 Cr Interest Revenue 4,264,410

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