Question

Determine Proper Amounts in Account Balances) Presented below are two independent situations.

(a) George Gershwin Co. sold \(2,000,000 of 10%, 10-year bonds at 104 on January 1, 2017. The bonds were dated January 1, 2017, and pay interest on July 1 and January 1. If Gershwin uses the straight-line method to amortize bond premium or discount, determine the amount of interest expense to be reported on July 1, 2017, and December 31, 2017.

(b) Ron Kenoly Inc. issued \)600,000 of 9%, 10-year bonds on June 30, 2017, for $562,500. This price provided a yield of 10% on the bonds. Interest is payable semiannually on December 31 and June 30. If Kenoly uses the effective interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2017.

Short answer

(a) Interest expenses for July 1, 2017, and December 31, 2017, will be$96,000.

(b) Interest expenses to be recorded on October 31, 2017, are $18,750.

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.

Step 2:Calculation of interest expenses for George Gershwin Co

Particular	Amount $
Cash interest paid $(\$2,000,000\times 10\%\times \frac{6}{12})$	$100,000
Less: Premium amortization	(4,000)
Interest expenses	$96,000

Interest expenses for July 1, 2017, and December 31, 2017, will be the same because the premium is amortized using the straight-line method.

Working note:

Calculation of value at which bonds are issued:

$\begin{array}{c}Issuedvalue=\frac{Totalparvalue\times \$104}{100}\\ =\frac{\$2,000,000\times \$104}{100}\\ =\$2,080,000\end{array}$

Calculation of Premium on bonds:

$\begin{array}{c}Premiumonbonds=Issuevalue-Parvalue\\ =\$2,080,000-\$2,000,000\\ =\$80,000\end{array}$

Calculation of amortization of premium each year:

$\begin{array}{c}Premiumamortizedeachyear=\frac{Totalpremium}{Lifeofbond}\\ =\frac{\$80,000}{20}\\ =\$4,000\end{array}$

Calculation of interest expenses on 31 Oct 2017

Date	Interest payment at the stated rate on face value (4.5%)	Interest expenses at the market rate on the previous year book value (5%)	Amortized discount	Unamortized discount	Bond payable	Book value of bond payable
30 June 2017				$37,500	$600,000	$562,500
31 Oct	$18,000	$18,750	$750	$36,750	$600,000	$563,250