Pierce Company issued 11% bonds, dated January 1, with a face amount of $800,000
ID: 2423206 • Letter: P
Question
Pierce Company issued 11% bonds, dated January 1, with a face amount of $800,000 on January 1, 2016. The bonds sold for $739,816 and mature in 2035 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Pierce determines interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2016, the fair value of the bonds was $730,000. The entire change in fair value was due to a change in the general (risk-free) rate of interest. Pierce's net income for the year will include:
Please show steps and calculations. Thanks.
Explanation / Answer
If there was no change in the interest rate than the value of the bond would have been $740617 as on 31 Dec 2016. But the fair value is decreased by $10617 making it $730000
So Interest Expense instead of $44412 will be $33795 therby reducing the interest expense by $10617 and incresaing the net income by $10617. This shows that market rate of interest has redued significantly
Date Interest Payment @5.5% Interest expenses at 6%*G Amortization of Bond C-B cr, balance in the a/c Bond Discount a/c Credit balance in the Bond payable Carrying value of Bond F-E Credit cash Debit Interest Expense Bond Discount Jan 1 2016 60184 800000 739816 30-Jun-16 44000 44389 389 59795 800000 740205 Dec, 31,2016 44000 44412 412 59383 800000 740617