Question

Garcia Company issues 10%, 15-year bonds with a par value of $240,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 8%, which implies a selling price of 117¼. The effective interest method is used to allocate interest expense.

1. What are the issuer’s cash proceeds from issuance of these bonds?

2. What total amount of bond interest expense will be recognized over the life of these bonds?

3. What amount of bond interest expense is recorded on the first interest payment date?

Short answer

1. The issuer’s cash proceeds from the issuance of the bonds are$281,400.
2. The total amount of bond interest expense is $318,600.
3. The First Interest Expense amount is$10,620.

Step-by-step solution

Meaning of Bond

Bonds are a written instrument issued by the company for a loan that the company takes from the investors for a certain period and pays the fixed interest amount.

Calculation of the issuer’s cash proceeds from the issuance of the bonds

Calculation of cash proceeds

$\begin{array}{rcl}\mathit{C}\mathit{a}\mathit{s}\mathit{h}\mathbf{ }\mathit{p}\mathit{r}\mathit{o}\mathit{c}\mathit{e}\mathit{e}\mathit{d}\mathit{s}\mathbf{ }\mathit{o}\mathit{n}\mathbf{ }\mathit{I}\mathit{s}\mathit{s}\mathit{u}\mathit{e}\mathbf{ }\mathit{o}\mathit{f}\mathbf{ }\mathit{b}\mathit{o}\mathit{n}\mathit{d}& \mathbf{=}& \mathbf{\$}\mathbf{240}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{117}\mathbf{.}\mathbf{25}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{281}\mathbf{,}\mathbf{400}\\ & & \end{array}$

Journal entry for the issue of bond

Date	Account and explanation	Debit ($)	Credit ($)
	Cash	281,400
	Bonds Payable		240,000
	Premium on Bond payable		41,400
	(To record the selling of bonds at a premium)

Calculation of total bond interest expense

Interest computation
Twenty payments of $12,000	$360,000
Less: Premium	41,400
Total bond interest expense	$318,600

Calculation of bond expense for the first year

$\begin{array}{rcl}\text{Bond} \text{interest} \text{expense}& =& \frac{\text{Total} \text{bond} \text{interest} \text{expense}}{\text{Number} \text{of} \text{interest} \text{periods}}\\ & =& \frac{\$318,600}{30}\\ & =& \$10,620\\ & & \end{array}$

Hence, the first Interest Expense amount is $10,620.