On January 1, 2016, Agricultural Crodn Union (ACU) issued 8%, Read the resuireme
ID: 2553655 • Letter: O
Question
On January 1, 2016, Agricultural Crodn Union (ACU) issued 8%, Read the resuirements Requirement 1. irea market interest rate is 0% when ACU The 8% bonds issued when the market interest rate is 6% wd be pend at Requirement 2. If the marknt interest rato is 9% when ACU issues its The 8% bonds issued when the market interest roto is g% wil be prod at Requirement 3. The issue price of the bonds is 98. Joumalize the bond tra 20-year bonds payable with face value of $900,000. The bonds pay intorost on June 30 and Decsmber 31. with face value of issues its bonds, will the bonds be priced at face value, at a premium, or at a discount? Explain They are in this markel, so investiors will pey to aoquire them. e face value, at a premium, or at a discount? Explain a discount a premium ro in this markot, so investiors will pary to aoquire them. face value payable are iamontizned using the straight-ine amorization method. Record debits fest, then coredits Select explanations on the last line of the journal entry. Round your anewers to the a Joumalize the issuance of the bonds on January 1, 2016 Date 2016 Jan. 1 Acoounts and Explanation Debit Credit b. Joumalize the payment of interest and amortizaton on June 30, 2016 Debit Credit Date Choose from any list or enter any number in the input felds and then continue to the next questionExplanation / Answer
Solution:
Requirement 1 & 2 --- First of all we need to know some basic rules for bond valuation that is
Some basic rules which should be remembered with regard to bonds are:
(i) When the required rate of return (market interest rate) equals the coupon rate, the bond sells at par value.
(ii) When the required rate of return (market interest rate) exceeds the coupon rate, the bond sells at a discount.
The discount declines as maturity approaches.
(iii) When the required rate of return (market interest rate) is less than the coupon rate, the bond sells at a premium.
The premium declines as maturity approaches.
Now, we will answer
Requirement 1 ---
The 8% bonds issued when the market interest rate is 6% will be prices at “A PREMIUM” They are attractive in this market, so investor will pay more than face value to acquire them.
The bonds are attractive because ACU is paying 8% interest on bonds as against the market interest rate 6%. Investors income will be on higher side from the bonds, it will attract investor to invest in bonds of ACU and investor will pay more than face value to acquire them.
Requirement 2 ---
The 8% bonds issued when the market interest rate is 9% will be prices at “A DISCOUNT” They are unattractive in this market, so investor will pay less than face value to acquire them.
Reason --- Company is paying interest 8% and the investor is getting interest 9% from the market, so the bonds are unattractive to the investors point of view. If they earn less than they are not willing to buy the bonds and expect to pay less than face value to acquire them.
Requirement 3 --- Journal Entry
Date
Account Titles and Explanation
Debit
Credit
(a)
Jan.1, 2016
Cash (Face Value 900,000*98%)
$882,000
Discount on Bonds Payable (Bal fig)
$18,000
Bonds Payable (Face Value)
$900,000
(Issued bonds at discount)
(b)
June.30, 2016
Interest Expense
$36,450
Cash Interest (Face value 900,000*8%*1/2 half yearly)
$36,000
Discount on Bonds Payable (Amortization)
$450
(paid semi annual interest and amortized discount)
(Semi Annual Amortization = $18,000 / Period to Maturity 20*2 = $450)
(c )
Dec.31, 2016
Interest Expense
$36,450
Cash Interest (Face value 900,000*8%*1/2 half yearly)
$36,000
Discount on Bonds Payable (Amortization)
$450
(paid semi annual interest and amortized discount)
(d)
Dec.31, 2035
Bonds Payable (face value)
$900,000
Cash
$900,000
(Retired bonds payable at maturity)
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Date
Account Titles and Explanation
Debit
Credit
(a)
Jan.1, 2016
Cash (Face Value 900,000*98%)
$882,000
Discount on Bonds Payable (Bal fig)
$18,000
Bonds Payable (Face Value)
$900,000
(Issued bonds at discount)
(b)
June.30, 2016
Interest Expense
$36,450
Cash Interest (Face value 900,000*8%*1/2 half yearly)
$36,000
Discount on Bonds Payable (Amortization)
$450
(paid semi annual interest and amortized discount)
(Semi Annual Amortization = $18,000 / Period to Maturity 20*2 = $450)
(c )
Dec.31, 2016
Interest Expense
$36,450
Cash Interest (Face value 900,000*8%*1/2 half yearly)
$36,000
Discount on Bonds Payable (Amortization)
$450
(paid semi annual interest and amortized discount)
(d)
Dec.31, 2035
Bonds Payable (face value)
$900,000
Cash
$900,000
(Retired bonds payable at maturity)
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