On January 1, 2009, AML company issues bonds maturing in 5 years. The par value
ID: 2445283 • Letter: O
Question
On January 1, 2009, AML company issues bonds maturing in 5 years. The par value of the bonds is $10,000, the annual coupon rate is 4-percent, and the compounding period is semiannually. The market initially prices these bonds using annual market interest rate 6-percent. The market interest rate on June 30, 2010 was 5% and the market interest rate on Dec. 31, 2012 was 8%.
1. Were the bonds issued at par, a discount or a premium?
2. Calculate the issue price.
3. Record journal entry on the date of issuance.
4. Will the interest expense increase or decrease over the years?
5. Calculate the interest expense on Jun 30, 2010.
6. Record journal entry on the interest expense on Jun 30, 2010.
Explanation / Answer
Given the current market rate of 6.000% for a similar bond, a bond with a face value of $10,000.00 and paying a coupon rate of 4.000% (compounding Semi-Annually), should be selling for $9,146.98 (selling at a discount)
Answer to question-1. Bond has been issued at a discount as per the above details.
Answer to question-2- Issue price of the bond was $9,146.98 (selling at a discount)(Given the current market rate of 6.000% for a similar bond, a bond with a face value of $10,000.00 and paying an annual coupon rate of 4.000% (compounding Semi-Annually))
Answer to question-3-
Cash Account Dr.$9146.98
Discount on bond payable account Dr. $853.02
Bond Payable A/c Cr.$ 10000
Answer to question-4. Interest expenses will neither decrease or increase with the market interest rate change. It will be as per coupan rate. Bond price will change because of change in market interest . If market interest rates decrease, the value of a bond will increase since the bond's stated fixed interest payments will be greater than the amounts available in new bonds issued at current market interest rates and vice versa.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.
Answer to question-5- Interest expenses on 30-06-2010- it is @4% coupan rate.on $10000 of bond= $200 for six month
Answer to question-6-journal entry on the interest expense on Jun 30, 2010.
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.
Interest Expenses Account Dr. $29.4
Discount on Bond Payable Cr. $ 170.60 ( $853.02/5)
Cash A/c Cr. 200
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