Question

(Issuance and Redemption of Bonds) Venezuela Co. is building a new hockey arena at a cost of \(2,500,000. It received a downpayment of \)500,000 from local businesses to support the project, and now needs to borrow \(2,000,000 to complete the project. It therefore decides to issue \)2,000,000 of 10.5%, 10-year bonds. These bonds were issued on January 1, 2016, and pay interest annually on each January 1. The bonds yield 10%.

Instructions

(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2016.

(b) Prepare a bond amortization schedule up to and including January 1, 2020, using the effective-interest method.

(c) Assume that on July 1, 2019, Venezuela Co. redeems half of the bonds at a cost of $1,065,000 plus accrued interest. Prepare the journal entry to record this redemption.

Short answer

1. Journal entry record debit to cash, credit to bonds payable, and premium on bond payable.
2. The bond's book value payable on 1 January 2020 is $2,043,559.
3. The business entity will incur a loss of $41,938on redemption.

Step-by-step solution

Definition of Interest Payable

Interest payable can be defined as the interest expenses that are incurred by the business entity but are not paid to the creditor. These are reported under current liabilities by the business entity

Journal entry for the issuance

Date	Accounts and Explanation	Debit ($)	Credit ($)
1 Jan 2016	Cash	2,061,450
	Bonds payable		2,000,000
	Premium on bonds payable		61,450

Working note:

Particular	Amount $
Present value of bonds $\left(\$2,000,000\times \frac{1}{{\left(1+0.10\right)}^{10}}\right)$	$771,000
Present value of interest payment $\left(\left(\$2,000,000\times 10.5\%\right)\times \frac{1-\frac{1}{{\left(1+0.10\right)}^{10}}}{\left(0.10\right)}\right)$	$1,290,450
Present value	$2,061,450

Bond amortization schedule

Date	Interest payment at the stated rate on face value (10.5%)	Interest expenses at the market rate on the previous year book value (10%)	Amortized premium	Unamortized premium	Bond payable	Book value of bond payable
1 Jan 2016				$61,450	$2,000,000	$2,061,450
1 Jan 2017	$210,000	$206,145	$3,855	57,595	2,000,000	2,057,595
1 Jan 2018	210,000	205,759.5	4,240.5	53,354.5	2,000,000	2,053,354.5
1 Jan 2019	210,000	205,335.45	4,664.55	48,689.95	2,000,000	2,048,689.95
1 Jan 2020	210,000	204,868.995	5,131.005	43,558.945	2,000,000	2,043,558.945

Journal entry to record the redemption

Date	Accounts and Explanation	Debit ($)	Credit ($)
Entry for accrual
	Interest expenses	51,217
	Premium on bond payable $\left(\$5131.005\times \frac{1}{2}\times \frac{1}{2}\right)$	1,283
	Interest payable $\left(\$210,000\times \frac{1}{2}\times \frac{1}{2}\right)$		52,500
Entry for reacquisition
	Bond payable	1,000,000
	Premium on bond payable	23,062
	Loss on redemption	41,938
	Cash		1,065,000

Working note:

Calculation of loss on redemption:

Particular	Amount $
Carrying amount of 1 Jan 2019	$2,048,689.95
Less: amortization of bond up to June 2019$\left(\frac{\$5131.005}{2}\right)$	(2,565.5025)
Carrying amount on 1 July 2019	$2,046,124.4475
Half of bonds retired$\left(\frac{\$2,046,124.4475}{2}\right)$	$1,023,062.22

Calculation of gain or loss on redemption:

Particular	Amount $
Reacquisition price	$1,065,000
Less: Carrying value	($1,023,062.22)
Loss on redemption	($41,937.77)

Calculation of premium written off:

Particular	Amount $
Carrying value on 1 July 2019	$2,046,124.4475
Less: Par value	(2,000,000)
	$46,124.4475
For 6months	$23,062.22