On January 1, 2018, Staheli Industries issued S800.000 of 12% bonds, dated July
ID: 2331756 • Letter: O
Question
On January 1, 2018, Staheli Industries issued S800.000 of 12% bonds, dated July 1. Interest of $48,000 is payable semiannually on June 30 and December 31. The bonds mature in three years, on December 31, 2021. The market interest rate for bonds of similar risk and maturity is IS%. The entire bond issue was purchased by Drake Company. 1- Required: A- Calculate the Present Value of the Bonds Purchased (Purchase Price). B. Prepare the Journal Entries for Drake Company. You should have three (3) entries On January 1, 2018, Staheli Industries issued $800,000 of 12% bonds, dated July 1. Interest of $48,000 is payable semiannually on June 30 and December 31. The bonds mature in three years, on December 31, 2021, The market interest rate for bonds of similar risk and maturity is 7%. The entire bond issue was purchased by Drake Company. 2- equired: A- Calculate the Present Value of the Bonds Purchased (Purchase Price). B- Prepare the Journal Entries for Drake Company. You should have three (3) entries.Explanation / Answer
1) Outstanding balance refers to the net sum of the balances in Bonds payable account and the Discount on bonds payable account.
The Bonds payable account, which is credited with the face value of the bonds on the date of issue, will remain the same till it is repaid.
But, the discount on bonds payable, which is a contra account for the bonds payable account, will decrease in value on every interest payment date, to the extent of the amount of discount amortized
In the balance sheet of a any date, the outstanding balance is determined as:
Bonds payable (which shows the face value of the bonds & does not change) = xxxxxxxx
Less: Discount on bonds payable = xxxxxx
Outstanding or carrying value of bonds = xxxxxxxx
As on 6/30/16 the balance is arrived at as 700,000 (Face value of the bonds) - (33367- 4664) = $671,297
Please see that $33367 is the original discount on the bonds payable. $4664 represents, the amount written off to interest expense account, which reduces the balance in the discount account to $28,703. Hence, outstanding balance is 700000-28703 =$671,297.
At the end of the life of the bond, the discount account will become 0 and the outstanding value will be $700,000, which is the face value of the bond (also the maturity value).
The journal entry on sale of the bonds is as given below:
Debit Cash $666,633
Debit Discount on bonds payable 33,367
Credit Bonds payable 700,000
The bonds payable account balance will not change.
However, the discount on bonds payable account will get reduced by the amount of discount amortized every half year. Its initial balance (debit) will be $33,367 and will get reduced by $4664, $4991 and so on every half year. The amount that will get reduced is shown in the 4th column (titled as 'increase in balance' and 'discount reduction')of the amortization schedule.
2) Note that the face value of the bond is $700000 with 12% annual coupon (paid semiannually). When the bonds were issued the market rate of interest was 14% and hence the bonds could be issued only for $666,633. In other words the value of the bonds is only $666,633 for an interest rate of 14% per annum. Hence, interest is applied at 14/2 = 7% for calculating interest expense. The interest expense for the first half year will be 666633*7% = $46,664
But note that interest is paid at 6% on 700000 = $42,000. The difference between interest expense and interest paid in cash of $4,664 will come from discount on bonds payable account