on January 1, the frat day of its fiscal ournal Final day of its fiscal year, Ch

Question

on January 1, the frat day of its fiscal ournal Final day of its fiscal year, Chin Company issued $23,100,000 of five-year, 9% bonds to finance its operations of producing and home improvement products. Interest is payable semiannually. The bonds were issued at a market effective) interest rate of 10%, resulting in Chin Company receiving cash of $22,208,059. Required: A. Journalize the entries to record the following (refer to the Chart of Accounts for exact wording of account titles): 1. Issuance of the bonds. 2. First semiannual interest payment. The bond discount amortization, using the straight-line method, is combined with the semiannual interest payment. (Round your answer to the nearest dollar.) 3. Second l interest payment. The bond discount amortization, using the straight-ine method, is combined with the semiannual interest payment. (Round your answer to the nearest dolar.) B. Determine the amount of the bond interest expense for the first year. C. Explain why the company was able to issue the bonds for only $22,208,059 rather than for the face amount of $23,100,000. Previous Next

Explanation / Answer

` CHIN COMPANY A. 1. Cash 22208059 Discount on bonds payable 891941 Bonds payable 23100000 A.2. Interest expense 1128694 Discount on bonds payable (891941/10) 89194 Cash ($23100000*4.5%) 1039500 A.3. Interest expense 1128694 Discount on bonds payable (891941/10) 89194 Cash ($23100000*4.5%) 1039500 B. Amount of bondinterest expense for the first year = 1128694+1128694 = 2257388 C. By the time the bonds were issued, the market interest rates, went up resulting in decrease in the value of the bond. This is because bond values move inversely with changes in market interest rates. Bond interest receipts are as per coupon rates, but bond price is the PV of the maturity value and semi annual coupon payments discounted at the market rate of interest. Because of this, when market interest rate moves up, the bond prices go down as the cash flows are discounted at a rate higher than the coupon rate. The opposite effect occurs when the market interest rate goes down. The price of the current issue can be calculated as follows: PV of the maturity value = 23100000*0.61391 = 14181321 PV of interest = 1039500*7.72173= 8026738 22208059 NOTE: Entries A.2 and A.3 are made on the assumption that bond interest is payable on June 30 and December 31. If they are payable on July 1 and January 1, then A.3 will be: On January 1: Interest payable 1039500 Cash 1039500 In such a case the second semi annual interest would be accrued on December 31, as below: Interest expense 1128694 Discount on bonds payable (891941/10) 89194 Interest payable 1039500

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