On January 1, 2018, Richard Corporation issued $800,000 of its 6% bonds for $743
ID: 2539598 • Letter: O
Question
On January 1, 2018, Richard Corporation issued $800,000 of its 6% bonds for $743,154. The bonds were priced to yield 7%. The bonds are dated January 1, 2018, and mature on December 31, 2027. Interest is payable semiannually on June 30 and December 31. Richard Corp. determines interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2018, the fair value of the bonds was $745,000 as determined by their market value in the over-the-counter market. Richard determined that all of the decrease in fair value was due to an increase in general interest rates. Richard’ earnings for the year will include:
a) gain from change in the fair value of debt of 2,245
b) loss from change in the fair value of debt of 2,467
c) loss from change in the fair value of debt of 2,595
Explanation / Answer
Solution:
Issue Price of the bonds = $743,154
Face Value of the bonds = $800,000
Issue price is less than face value of the bonds, it means bonds are issued at discount.
Discount on Bonds Payable = 800,000 – 743,154 = $56,846
We need to find out the book value of the bonds as on Dec 31, 2018 in order to calculate gain or loss from the change in fair value.
Since the company is using effective interest rate method for amortization, we need to prepare Bond Discount Amortization table using effective interest rate for 2 periods
Schedule of Amortization of Bond DISCOUNT (Effective Rate Method)
Payment intervals
Date
Interest Expense (Carrying Value at the beginning of period x Market Interest Rate 7% * 1/2half yearly)
Cash Paid (Face Value of the Bonds $800,000 x Coupon Rate 6% * 1/2 half yearly)
Discount Amortization (Interest Expense - Cash Paid)
Unamortized Bond Discount
Par Value of Bonds Payable
Book Value (Par Value - Balance of Unamortized Bond Discount)
0
Jan.1, 2018
$56,846
$800,000
$743,154
1
June.30, 2018
$26,010
$24,000
$2,010
$54,836
$800,000
$745,164
2
Dec.31, 2018
$26,081
$24,000
$2,081
$52,755
$800,000
$747,245
Carrying Value or Book Value of the Bonds as on Dec 31, 2018 = $747,245
Fair Value of the bonds as on Dec 31, 2018 = $745,000
Fair Value is less than book value of the bonds, it means company have to pay less amount then actual.
Gain from change in the fair value of the debt = Carrying Value 747,245 – Fair Value 745,000 = $2,245
Hence, the correct option is a) gain from change in the fair value of debt of 2,245
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Schedule of Amortization of Bond DISCOUNT (Effective Rate Method)
Payment intervals
Date
Interest Expense (Carrying Value at the beginning of period x Market Interest Rate 7% * 1/2half yearly)
Cash Paid (Face Value of the Bonds $800,000 x Coupon Rate 6% * 1/2 half yearly)
Discount Amortization (Interest Expense - Cash Paid)
Unamortized Bond Discount
Par Value of Bonds Payable
Book Value (Par Value - Balance of Unamortized Bond Discount)
0
Jan.1, 2018
$56,846
$800,000
$743,154
1
June.30, 2018
$26,010
$24,000
$2,010
$54,836
$800,000
$745,164
2
Dec.31, 2018
$26,081
$24,000
$2,081
$52,755
$800,000
$747,245