Question

Valdez issues \(450,000 of 13%, four-year bonds dated January 1, 2017, that pay interest semiannually on June 30 and December 31. They are issued at \)493,608, and 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 the one in 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 106.

Analysis Component

6. Assume that the market rate on January 1, 2017, is 14% instead of 10%. Without presenting numbers, describe how this change affects the amounts reported on Valdez’s financial statements.

Short answer

(1) Cash account is debited by $493,608, and crediting premium on bonds payable by $43,608 and bonds payable by $450,000.

(2) The total bond interest expense is $190,392.

(3) Amortization table is prepared in Step 4.

(4) Journal entries are recorded in Step 5.

(5) Bonds payable account is debited by $473,912, loss on retirement of bonds payable by $3,088, and crediting bonds payable by $477,000.

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

Step-by-step solution

Explanation on bonds payable

The bonds payable are the part of long term liabilities, wherein bondholders receives fixed amount of interest periodically and face value at maturity.

(1) Journal entry to record bonds’ issuance

Jan 1	Cash	$493,608
	Premium on bond payable		$43,608
	Bonds payable		$450,000
	Record issuance of bonds payable

(2) Computation of total bond interest expense     

Interest paid ($29,250*8)	$234,000
Less: Premium on bonds payable ($493,608 -$450,000)	(43,608)
Total bond interest expense	$190,392

(3) Amortization table

Bonds: $325,000 Par Value, Semiannual Interest Payments, Two-Year Life, 6.5% Semiannual Contract Rate, 5% Semiannual Market Rate
		A	B	C	D	E
	Semi-annual period end	Cash interest paid (6.5% of $450,000)	Bond interest expense (5% of prior E)	Premium amortization (B)-(A)	Unamortized premium Prior (D)-(C)	Carrying value $450,000+(D)
0	01-01-2017				$43,608	$493,608
1	30-06-2017	29,250	24,680	4,570	$39,038	$489,038
2	31-12-2017	29,250	24,452	4,798	$34,240	$484,240
3	30-06-2018	29,250	24,212	5,038	$29,202	$479,202
4	31-12-2018	29,250	23,960	5,290	$23,912	$4,73,912

(4) Entry to record the first two interest payment

June 30 2017	Bond interest expense	$24,680
	Premium on bonds payable	$4,570
	Cash		$29,250
	Pay semi-annual interest and record amortization.

Dec 31 2017	Bond interest expense	$24,452
	Premium on bonds payable	$4,798
	Cash		$29,250
	Pay semi-annual interest and record amortization

(5) Entry to record bonds’ retirement

Jan 1 2019	Bonds payable	$4,73,912
	Loss on retirement of bonds ($473,912 -$477,000)	$3,088
	Cash ($450,000 x 106%)		$477,000
	Record bonds’ retirement

(6) Effect of change in market rate

If the market rate on January 1, 2017, is 14% instead of 10%, then the issue of bond is on discount instead of on premium. As the market rate (14%) at the time of issue is greater than the contract rate (13%). In the financial statement, under long term liabilities section, bonds payable will be reported at face value less discount on bonds payable.