On July 1, 2016, Merideth Industries Inc. issued $28,500,000 of 10-year, 8% bond
ID: 2419535 • Letter: O
Question
On July 1, 2016, Merideth Industries Inc. issued $28,500,000 of 10-year, 8% bonds at a market (effective) interest rate of 9%, receiving cash of $26,646,292. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year. Required: 1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, 2016.* 2. Journalize the entries to record the following:* a. The first semiannual interest payment on December 31, 2016, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.) b. The interest payment on June 30, 2017, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.) 3. Determine the total interest expense for 2016. 4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest? 5. Compute the price of $26,646,292 received for the bonds by using the tables shown in Present Value Tables. (Round to the nearest dollar.)f *Be sure to include the year in the date for the entries. Refer to the Chart of Accounts for exact wording of account titles.
Explanation / Answer
When a corporation is preparing a bond to be issued/sold to investors, it may have to anticipate the interest rate to appear on the face of the bond and in its legal contract.
In the given problem, corporation prepares a $28,500,000 bond with an interest rate of 8%. Just prior to issuing the bond, a financial crisis occurs and the market interest rate for this type of bond increases to 9%. If the corporation goes forward and sells its 8% bond in the 9% market, it will receive less than $28,500,000. When a bond is sold for less than its face amount, it is said to have been sold at a discount. The discount is the difference between the amount received (excluding accrued interest) and the bond's face amount. The difference is known by the terms discount on bonds payable, bond discount, or discount.
Corporation prepares a 8% $28,500,000 bond dated July 1st 2016. The interest payments of $1,140,000 ($28,500,000 x 8% x 6/12) will be required on each June 30 and December 31 until the bond matures.
1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, 2016.
To illustrate the accounting for bonds payable issued at a discount, the 8% bond is sold in the 9% market for $26,646,292 plus $0 accrued interest on January 1, 2014. The corporation's journal entry to record the sale of the bond will be:
Date
Account name
Debit
credit
July 1st 2016
Cash
Discount on Bonds payable
Bonds payable
26,646,292
18,53,708
28,500,000
The account Discount on Bonds Payable (or Bond Discount or Unamortized Bond Discount) is a contra liability account since it will have a debit balance. Discount on Bonds Payable will always appear on the balance sheet with the account Bonds Payable. In other words, if the bond is a long-term liability, both Bonds Payable and Discount on Bonds Payable will be reported on the balance sheet as long-term liabilities. The combination or net of these two accounts is known as the book value or the carrying value of the bonds. On January 1, 2014 the book value of this bond is $26,646,292 (the $28,500,000 credit balance in Bonds Payable minus the debit balance of $1,853,703 in Discount on Bonds Payable.)
2. Journalize the entries to record the following:* a. The first semiannual interest payment on December 31, 2016, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.)
Discount on Bonds Payable with Straight-Line Amortization
Over the life of the bond, the balance in the account Discount on Bonds Payable must be reduced to $0. Reducing this account balance in a logical manner is known as amortizing or amortization. Since a bond's discount is caused by the difference between a bond's stated interest rate and the market interest rate, the journal entry for amortizing the discount will involve the account Interest Expense.
In our Problem, the bond discount of $1,853,708 results from the corporation receiving only $26,646,292 from investors, but having to pay the investors $28,500,000 on the date that the bond matures. The discount of $1,853,708 is treated as an additional interest expense over the life of the bonds. When the same amount of bond discount is recorded each year, it is referred to as straight-line amortization.
In this Problem, the straight-line amortization would be $185,371 ($1,853,708 divided by the 10-year life of the bond).
The interest expense for the year 2014 will be $2,280,000 (the two semiannual interest payments of $1,140,000 each plus the two semiannual amortizations of bond discount of $92,686 each). The following T-account for Interest Expense shows the entries for the year 2014:
Date
Account name
Debit
credit
Dec 31st 2016
Interest Expense
Discount on Bonds payable
Cash
1,232,686
92,686
1.140.000
B.The interest payment on June 30, 2017, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar.)
Date
Account name
Debit
credit
June 30th 2017
Interest Expense
Discount on Bonds payable
Cash
1,232,686
92,685
1.140.000
3.Determine the total interest expense for 2016
The total interest expenses are = $1,232,686 for 2016.
4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest?
The prior to offering the bond to investors on July 1, the market interest rate for this bond increases to 9%. The corporation decides to sell the 8% bond rather than changing the bond documents to the market interest rate. Since the corporation is selling its 8% bond in a bond market which is demanding 9%, the corporation will receive less than the bond's face amount.
Date
Account name
Debit
credit
July 1st 2016
Cash
Discount on Bonds payable
Bonds payable
26,646,292
18,53,708
28,500,000
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