Teletronics, Inc. issued $1,000,000 of 6.5%, 8-year bonds dated June 1, 2001 , w

Question

Teletronics, Inc. issued $1,000,000 of 6.5%, 8-year bonds dated June 1, 2001 , with semiannual interest payments on June 1 and December 1. The bonds were issued on June 2001 at 103 3/8. Teletronics's year-end is December 31 a. Were the bonds issued at a premium, a discount, or at par? b. Was the market rate of interest higher, lower, or the same as the contract rate of interest? c. If the company uses the straight-line method of amortization, what is the amount of d. What is the carrying value of the bonds on December 31, 2001? interest expense Teletronics will show for the year ended December 31, 2001?

Explanation / Answer

a.

The bonds were issued at 103 3/8. This means the bonds were issed at 103.375% of their face value. Since the bonds were issued at a price higher than their face value, the bonds were issued at a premium.

b.

Bonds are issued at a premium when the market interest rate is lower than the contract rate. Therefore, the market interest rate was lower than the contract rate.

c.

Issue price = $1,000,000 x 103.375% = $1,033,750

Face value = $1,000,000

Premium on bonds = $1,033,750 - $1,000,000 = $33,750

Number of semiannual periods over the life of the bonds = 8 x 2 = 16

Premium amortized for each semiannual period = $33,750/16 = $2,109.375

Interest paid for each semiannual period = $1,000,000 x 6.5% x 1/2 = $32,500

Interest expense to be shown for each semiannual period = $32,500 - $2,109.375 = $30,390.625

d.

Carrying value of bonds on December 31, 2001

= Issue price - Premium amortized

= $1,033,750 - $2,109.375

= $1,031,640.625

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