On January 1, 2018, Entity A issued 8% bonds dated January 1, 2018, with a face
ID: 2609076 • Letter: O
Question
On January 1, 2018, Entity A issued 8% bonds dated January 1, 2018, with a face amount of $10 million. The bonds mature in 2022 (5 years). For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31. A. Prepare a partial balance sheet showing the bonds at December 31, assuming that Entity A had used the effective interest method from the inception. B. Why might a company utilize the straight-line method to amortize premium or discount? When is it permissible to do so?
Explanation / Answer
Ans. A
Since bonds coupon rate of 8% is lower than market rate of 10% and bond is issued at discount. Market value of bonds will be arrived as follows:
Coupon payments = 10,000,000 x 8% x ½ = 400,000 for six month
Present value of coupon = $400,000 x 7.7217349* = $3,088,694
Present value of Face value = $10M x 0.6139133** = $6,139,133
Total of present values = $9,227,827
*Present value of ordinary annuity of $1 i = 5%, n = 10
** Present value of $1, I = 5%, n = 10
Discount on bonds = $10M - $9,227,827 = $772,173
Date
Interest Paid
Interest Expense
Discount amortized
Unamortized Discount
Carrying Value
January 1, 2018
772,173
9,227,827
June 30, 2018
$ 400,000
461,391
$ 61,391
$ 710,782
$ 9,289,218
December 31, 2018
$ 400,000
464,461
$ 64,461
$ 646,321
$ 9,353,679
Balance Sheet (Partial)
Long term Debt:
Bonds Payable
$ 10,000,000
Less: Unamortized Discount
$ 646,321
Net Bonds Payable
$ 9,353,679
Ans. B
Straight line amortization method amortizes equal $ amount to each period and easy to use and also, there is no significant difference from effective amortization so that can be the reason of using it.
Date
Interest Paid
Interest Expense
Discount amortized
Unamortized Discount
Carrying Value
January 1, 2018
772,173
9,227,827
June 30, 2018
$ 400,000
461,391
$ 61,391
$ 710,782
$ 9,289,218
December 31, 2018
$ 400,000
464,461
$ 64,461
$ 646,321
$ 9,353,679
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