Question

Ike issues \(180,000 of 11%, three-year bonds dated January 1, 2017, that pay interest semiannually on June 30 and December 31. They are issued at \)184,566. Their market rate is 10% at the issue date.

Required

1. Prepare the January 1, 2017, journal entry to record the bonds’ issuance.
2. Determine the total bond interest expense to be recognized over the bonds’ life.
3. Prepare an effective interest amortization table like Exhibit 10B.2 for the bonds’ first two years.
4. Prepare the journal entries to record the first two interest payments.
5. Prepare the journal entry to record the bonds’ retirement on January 1, 2019, at 98.

Analysis Component

6. Assume that the market rate on January 1, 2017, is 12% instead of 10%. Without presenting numbers, describe how this change affects the amounts reported on Ike’s financial statements.

Short answer

(1) Cash account is debited by $184,566, and premium on bonds payable is credited by by $4,566 and bonds payable credited by $180,000.

(2) The total bond interest expense is $54,834.

(3) Amortization table is prepared in Step 4.

(4) Journal entries are recorded in Step 5.

(5) Bonds payable account is debited by $181,670, and gainon retirement of bonds payable is credited by $5,270, and bonds payable is credited by $176,400.

(6) Bonds payable will be reported at discount in balance sheet.

Step-by-step solution

Premium on bonds payable

In case the issue price of bonds payable is higher than the par value, then it means that bonds are issued at premium.

(1) Journal entry to record bonds’ issuance

Jan 1	Cash	$184,566
	Premium on bond payable		$4,566
	Bonds payable		$180,000
	Record issuance of bonds payable

(2) Computation of total bond interest expense     

Account repaid ($180,000 x 11% x ½) x (3 x2)	$59,400
Less: Premium ($184,566-$180,000)	(4,566)
Total bond interest expense	$54,834

(3) Amortization table

Bonds: $180,000 Par Value, Semi-annual Interest Payments, Two-Year Life, 5.5% Semi-annual Contract Rate, 5% Semi-annual Market Rate
		A	B	C	D	E
	Semi-annual period end	Cash interest paid (5.5% of $180,000)	Bond interest expense (5% of prior E)	Premium amortization (B)-(A)	Unamortized premium Prior (D)-(C)	Carrying value $180,000+(D)
0	01-01-2017				$4,566	$184,566
1	30-06-2017	9,900	9,228	672	$3,894	$183,894
2	31-12-2017	9,900	9,195	705	$3,189	$183,189
3	30-06-2018	9,900	9,159	741	$2,448	$182,448
4	31-12-2018	9,900	9,122	778	$1,670	$181,670

(4) Entry to record the first two interest payment

June 30 2017	Bond interest expense	$9,228
	Premium on bonds payable	$672
	Cash		$9,900
	Pay semi-annual interest and record amortization.

Dec 31 2017	Bond interest expense	$9,195
	Premium on bonds payable	$705
	Cash		$9,900
	Pay semi-annual interest and record amortization

(5) Entry to record bonds’ retirement

Jan 1 2019	Bonds payable	$181,670
	Gain on retirement of bonds payable ($181,670-$176,400)		$5,270
	Cash ($180,000 x 98%)		$176,400
	Record bonds’ retirement

(6) Effect if market rate changes

If the market rate on January 1, 2017, is 12% instead of 10%, then the issue of bond is on discount instead of on premium. As the market rate (12%) at the time of issue is greater than the contract rate (11%).