On January 1, Year 1, Acorn Financial Corp. issued 850 convertible bonds. Each $
ID: 2427016 • Letter: O
Question
On January 1, Year 1, Acorn Financial Corp. issued 850 convertible bonds. Each $1,000 face value bond is convertible into 5 shares of common stock. The bonds have a 10 year term to maturity and pay interest semiannually. Acorn's common stock has a par value of $20.00 per share. The bonds have a stated interest rate of 4% and pay interest semiannually. The convertible bonds were sold for $875,500. Bond issue costs of $50,000 will be subtracted from the bond sale proceeds to be received by Acorn. The bonds were sold to yield a market interest rate of 3%. Acorn will use the effective interest method to amortize the bond discount and/or premium. Round all amounts to the nearest dollar.
Explanation / Answer
ANSWER 1 : Record the journal entry for the issuance of the convertible bonds on January 1, Year 1
Cash Dr $875500
Bonds Payable 850000
Premium on Bonds Payable 25500
Issue Expense Dr 50000
Cash 50000
ANSWER 2:Record the journal entries on June 30, Year 1 to recognize interest expense and the amortization of the bond issue cost for the first six months of Year 1
NOTE : The effective interest rate is multiplied times the bond's book value at the start of the accounting period to arrive at each period's interest expense.
Bond Value at the start of the period = $ 875500
Interest actually due on bonds = ($ 850000* 4% ) / 2 = $17000
Interest expense =( $ 875500 * 3%) / 2 = $ 13133
Prmium on Bonds payable = $ 17000-13133 = $ 3867
ENTRY -
Interest expense Dr 13133
Premium on Bonds Payable Dr 3867
Cash 17000