Question

Legacy issues \(325,000 of 5%, four-year bonds dated January 1, 2017, that pay interest semiannually on June 30 and December 31. They are issued at \)292,181, and their market rate is 8% 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 a straight-line amortization table like the one in Exhibit 10.7 for the bonds’ first two years.
4. Prepare the journal entries to record the first two interest payments.

Analysis Component

1. Assume the market rate on January 1, 2017, is 4% instead of 8%. Without providing numbers, describe how this change affects the amounts reported on Legacy’s financial statements

Short answer

1. The bond is issued at a discount of$32,819
2. The total bond interest expense is $97,819
3. The carrying value of the bond at the end of the second year is $3,08,589
4. The bond interest expense recognized is $1,2227
5. If the contract rate is more than the market rate, then the premium on bonds payable is recorded.

Step-by-step solution

Meaning of bond issued at discount

A discount on bonds payable occurs when a company issues bonds with a contract rate less than the market rate. It means the issue price is less than the par value-the issuer gets less money at issuance than the issuer must pay back at maturity.

(1) Journal entry to record issuance of bond

Date	Account and explanation	Debit ($)	Credit ($)
Jan 1, 2017	Cash	292,181
	Discount on bonds payable	32,819
	Bond payable		325,000
	(To record issue of bond at discount)

(2) Computation of total bond interest expense     

Particulars	Amount ($)
Eight Payments of $8,125	$65,000
Add: Discount	$32,819
Total bond interest expense	$97,819

Working note:

$\begin{array}{c}Straightlinediscountamortization=\frac{Discount}{semiannualperiods}\\ =\frac{\$32,819}{8}\\ =\$4,102\end{array}$

Note: Total bond discount of $32,819 less accumulated periodic amortization of $4,102 per semi-annual interest.

Carrying value for each period is calculated by $325,000 less unamortized discount.

(4) Entry to record the first two interest payment

Date	Account and explanation	Debit ($)	Credit ($)
June 30 2017	Bond interest expense	12,227
	Discount on bonds payable		4,102
	Cash		8,125
	(To pay semi-annual interest and amortization)
Dec 31 2017	Bond interest expense	12,227
	Discount on bonds payable		4,102
	Cash		8,125
	(To record semi-annual interest and amortization)

(5) Explanation

If the market rate on January 1, 2017, is 4% instead of 8%, the issuance of bonds is at a premium. As the market rate(4%) is less than the contract rate (5%).