Question

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, $1,000facevaluebondsat97.InterestpaymentdatesareApril1andOctober1,andthecompanyusesthestraight-linemethodofbonddiscountamortization.OnMarch1,2018,Seminoletookadvantageoffavorablepricesofitsstocktoextinguish6,000ofthebondsbyissuing200,000sharesofits$10 par value common stock. At this time, the accrued interest was paid in cash. The company’s stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)

Short answer

1. The bonds are issued at a discount of$450,000.
2. Semi-annual interest paid in cash total as$825,000.
3. Accrued interest total as $412,500.
4. The business entity generates a loss on redemption of $369,000.

Step-by-step solution

Definition of Bond Amortization

Bond amortization can be defined as the method under which the business entity spread the discount or the premium on the bonds payable over its life. It is generally done using methods such as the straight-line method and the effective interest method.

Issuance of bonds

Date	Accounts and Explanation	Debit ($)	Credit ($)
1 April 2017	Cash$\left(15,000\times \$1,000\times 97\%\right)$	$14,550,000
	Discount on bond payable	$450,000
	Bond payable		$15,000,000
	(To record the issuance of bonds)

Payment of semi-annual interest

Date	Accounts and Explanation	Debit ($)	Credit ($)
1 October 2017	Interest expenses	$840,000
	Cash		$825,000
	Discount on bond payable		$15,000
	(To record the payment of semi-annual interest)

Working note:

Calculation of interest paid in cash:

$\begin{array}{rcl}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathit{p}\mathit{a}\mathit{i}\mathit{d}\mathit{i}\mathit{n}\mathit{c}\mathit{a}\mathit{s}\mathit{h}& \mathbf{=}& \mathit{F}\mathit{a}\mathit{c}\mathit{e}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\mathit{o}\mathit{f}\mathit{b}\mathit{o}\mathit{n}\mathit{d}\mathit{s}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\mathbf{\times }\frac{\mathbf{6}}{\mathbf{12}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{11}\mathbf{\%}\mathbf{\times }\frac{\mathbf{6}}{\mathbf{12}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{825}\mathbf{,}\mathbf{000}\\ & & \end{array}$

Calculation of discount on bond payable:

There are a total of 180 months in 15 years. Therefore, the discount amortized for 6 months totals as:

$\begin{array}{rcl}\mathit{D}\mathit{i}\mathit{s}\mathit{c}\mathit{o}\mathit{u}\mathit{n}\mathit{t}\mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{e}\mathit{d}& \mathbf{=}& \frac{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{d}\mathbf{i}\mathbf{s}\mathbf{c}\mathbf{o}\mathbf{u}\mathbf{n}\mathbf{t}}{\mathbf{180}}\mathbf{\times }\mathbf{6}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{450}\mathbf{,}\mathbf{000}}{\mathbf{180}}\mathbf{\times }\mathbf{6}\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{000}\\ & & \end{array}$

Accrual of interest expenses

Date	Accounts and Explanation	Debit ($)	Credit ($)
31 Dec 2017	Interest expenses	$420,000
	Interest payable		$412,500
	Discount on bond payable $\left(\$15,000\times \frac{3}{6}\right)$		$7,500

Calculation of accrued interest:

$\begin{array}{rcl}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathit{p}\mathit{a}\mathit{i}\mathit{d}\mathit{i}\mathit{n}\mathit{c}\mathit{a}\mathit{s}\mathit{h}& \mathbf{=}& \mathit{F}\mathit{a}\mathit{c}\mathit{e}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\mathit{o}\mathit{f}\mathit{b}\mathit{o}\mathit{n}\mathit{d}\mathit{s}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\mathbf{\times }\frac{\mathbf{3}}{\mathbf{12}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{11}\mathbf{\%}\mathbf{\times }\frac{\mathbf{3}}{\mathbf{12}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{412}\mathbf{,}\mathbf{500}\\ & & \end{array}$

Extinguishment of 6,000 bonds

Date	Accounts and Explanation	Debit ($)	Credit ($)
1 March 2018	Interest expenses	$112,000
	Interest payable $\left(\$412,500\times \frac{6,000}{15,000}\right)$	$165,000
	Cash		$275,000
	Discount on bond payable		$2,000
1 March 2018	Bond payable	$6,000,000
	Loss on redemption	$369,000
	Discount on bonds payable		$169,000
	Common stock		$2,000,000
	Paid-in-capital in excess of par		$4,200,000

Working note:

Calculation of cash paid to retire bonds:

$\begin{array}{rcl}\mathit{C}\mathit{a}\mathit{s}\mathit{h}\mathit{p}\mathit{a}\mathit{i}\mathit{d}\mathit{t}\mathit{o}\mathit{b}\mathit{o}\mathit{n}\mathit{d}\mathit{h}\mathit{o}\mathit{l}\mathit{d}\mathit{e}\mathit{r}\mathit{s}& \mathbf{=}& \mathit{B}\mathit{o}\mathit{n}\mathit{d}\mathit{s}\mathit{r}\mathit{e}\mathit{t}\mathit{i}\mathit{r}\mathit{e}\mathit{d}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\mathbf{\times }\frac{\mathbf{5}}{\mathbf{12}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{6}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{11}\mathbf{\%}\mathbf{\times }\frac{\mathbf{5}}{\mathbf{12}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{275}\mathbf{,}\mathbf{000}\\ & & \end{array}$

Calculation of Discount on bond payable:

$\begin{array}{rcl}\mathit{D}\mathit{i}\mathit{s}\mathit{c}\mathit{o}\mathit{u}\mathit{n}\mathit{t}\mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{e}\mathit{d}& \mathbf{=}& \frac{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{d}\mathbf{i}\mathbf{s}\mathbf{c}\mathbf{o}\mathbf{u}\mathbf{n}\mathbf{t}}{\mathbf{180}}\mathbf{\times }\mathbf{2}\mathbf{\times }\frac{\mathbf{6}\mathbf{,}\mathbf{000}}{\mathbf{15}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{450}\mathbf{,}\mathbf{000}}{\mathbf{180}}\mathbf{\times }\mathbf{2}\mathbf{\times }\frac{\mathbf{6}\mathbf{,}\mathbf{000}}{\mathbf{15}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{000}\\ & & \end{array}$

Calculation of carrying amount of bonds:

Particular	Amount $
Bond payable	$6,000,000
Less: Unamortized discount $\left(\$450,000\times \frac{180-11}{180}\times \frac{6,000}{15,000}\right)$	(169,000)
Carrying value	$5,831,000

Calculation of loss on redemption of bonds:

Particular	Amount $
Reacquisition price	$6,200,000
Less: Carrying value	(5,831,000)
Loss on redemption	$369,000