On January 1, 2017, Nichols Company issued for \(1,085,800 its 20-year, 11% bonds that have a maturity value of \)1,000,000 and pay interest semiannually on January 1 and July 1. The following are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date.
1 | Bonds payable (maturing January 1, 2037) | \(1,000,000 |
| Unamortized premium on bonds payable | 85,800 |
| Total bond liability | \)1,085,800 |
| | |
2 | Bonds payable—principal (face value \(1,000,000 maturing January 1, 2037) | \) 142,050a |
| Bonds payable—interest (semiannual payment \(55,000) | 943,750b |
| Total bond liability | \)1,085,800 |
| | |
3 | Bonds payable—principal (maturing January 1, 2037) | \(1,000,000 |
| Bonds payable—interest (\)55,000 per period for 40 periods) |
2,200,000 |
| Total bond liability | \(3,200,000 |
aThe present value of \)1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per period
bThe present value of \(55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.
Instructions
(a) Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.
(b) Explain why investors would pay \)1,085,800 for bonds that have a maturity value of only $1,000,000.
(c)Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose: (1) The coupon or nominal rate. (2) The effective or yield rate at date of issue.
(d)If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of the issue be affected by an increase or a decrease in the market rate of interest?
