CHAPTER 15



CHAPTER 15

QUESTIONS

1. A bond is a liability of the issuing company. A share of stock represents an ownership interest.

5. A bond indenture is a legal contract between the issuing company and the bondholders that states the obligations and rights of both parties. It specifies such items as the par value of the bonds, the contract interest rate, the due dates for interest payments, and the maturity date(s) of the bonds. It also may name a trustee, describe the bond issue in detail, and provide for a sinking fund.

11. The issue price of a $2,000 bond sold at 98 ¼ is 98.25% of $2,000, or $1,965. The issue price of a $6,000 bond priced at 101 ½ is 101.5% of $6,000, or $6,090.

Quick Study 15-1

1. Bond’s cash proceeds: $250,000 x 0.875 = $218,750

|2. |Twenty semiannual interest payments of $10,000 |$200,000 |

| |Plus bond discount ($250,000 - $218,750) | 31,250 |

| |Total bond interest expense |$231,250 |

3. Bond interest expense on first payment date:

$231,250 / 20 semiannual periods = $11,562.50

Quick Study 15-2

1. Bond’s cash proceeds: $240,000 x 1.1725 = $281,400

|2. |Thirty semiannual interest payments of $12,000 |$360,000 |

| |Less premium ($281,400 - $240,000) | (41,400) |

| |Total bond interest expense |$318,600 |

3. Bond interest expense on first payment date:

$281,400 x 4% = $11,256

Quick Study 15-3

2002

|Jan. 1 |Cash |218,750 | |

| |Discount on Bonds Payable |31,250 | |

| | Bonds Payable | |250,000 |

| | To record issuing bonds at a discount. | | |

|Jan. 1 |Cash |281,400 | |

| | Bonds Payable | |240,000 |

| | Premium on Bonds Payable | |41,400 |

| | To record issuing bonds at a premium. | | |

Exercise 15-1

1. Semiannual interest payment = $3,400,000 x 9% x 1/2 = $153,000

2. Journal entries:

2002

|(a) | | | |

|Jan. 1 |Cash |3,400,000 | |

| | Bonds Payable | |3,400,000 |

| | Sold bonds at par. | | |

| | | | |

|(b) | | | |

|June 30 |Bond interest expense |153,000 | |

| | Cash | |153,000 |

| | Paid semiannual interest on bonds. | | |

| | | | |

|(c) | | | |

|Dec. 31 |Bond interest expense |153,000 | |

| | Cash | |153,000 |

| | Paid semiannual interest on bonds. | | |

3.

2002

|(a) | | | |

|Jan. 1 |Cash* |3,332,000 | |

| |Discount on Bonds Payable |68,000 | |

| | Bonds Payable | |3,400,000 |

| | Sold bonds at 98. *($3,400,000 x 0.98) | | |

| | | | |

|(b) | | | |

|Jan. 1 |Cash* |3,468,000 | |

| | Premium on Bonds Payable | |68,000 |

| | Bonds Payable | |3,400,000 |

| | Sold bonds at 102. *($3,400,000 x 1.02) | | |

Exercise 15-2

1. Semiannual interest payment = $800,000 x 6% x ½ year = $24,000

2. Number of payments = 10 years x 2 per year = 20 semiannual payments

3. The 6% contract rate is less than the 8% market rate; therefore, the bonds are issued at a discount.

4. Estimation of the market price at the issue date:

|Cash Flow |Table |Table Value* |Amount |Present Value |

|Par (maturity) value |B.1 | 0.4564 |$800,000 |$365,120 |

|Interest (annuity) |B.3 |13.5903 | 24,000 | 326,167 |

|Price of bonds | | | |$691,287 |

*The table values are based on a discount rate of 4% (half the annual market rate) and 20 periods (semiannual payments).

5.

| |Cash |691,287 | |

| |Discount on Bonds Payable |108,713 | |

| | Bonds Payable | |800,000 |

| | Sold bonds at a discount on the stated issue date. | |

Exercise 15-3

1. Semiannual interest payment = $150,000 x 10% x ½ year = $7,500

2. Number of payments = 5 years x 2 per year = 10 semiannual payments

3. The 10% contract rate is greater than the 8% market rate; therefore, the bonds are issued at a premium.

4. Estimation of the market price at the issue date:

|Cash Flow |Table |Table Value* |Amount |Present Value |

|Par (maturity) value |B.1 |0.6756 |$150,000 |$101,340 |

|Interest (annuity) |B.3 |8.1109 | 7,500 | 60,832 |

|Price of bonds | | | |$162,172 |

*The table values are based on a discount rate of 4% (half the annual market rate)

and 10 periods (semiannual payments).

5.

| |Cash |162,172 | |

| | Premium on Bonds Payable | |12,172 |

| | Bonds Payable | |150,000 |

| | Sold bonds at a premium on the stated issue date. | |

Problem 15-2A

Part 1

2002

|Jan. 1 |Cash |3,456,448 | |

| |Discount on Bonds Payable |543,552 | |

| | Bonds Payable | |4,000,000 |

| | Sold bonds on stated issue date. | | |

Part 2

[Note: The semiannual amounts for (a), (b), and (c) below are the same throughout the bonds’ life because this company uses straight-line amortization.]

(a) Cash Payment = $4,000,000 x 6% x 6/12 year = $120,000

(b) Discount = $4,000,000 - $3,456,448 = $543,552

Straight-line discount amortization = $543,552 / 30 semiannual periods

= $18,118

(c) Bond interest expense = $120,000 + $18,118 = $138,118

Part 3

|Thirty payments of $120,000 |$3,600,000 |

|Par value at maturity | 4,000,000 |

|Total repaid |$7,600,000 |

|Less amount borrowed | (3,456,448) |

|Total bond interest expense |$4,143,552 |

or:

|Thirty payments of $120,000 |$3,600,000 |

|Plus discount | 543,552 |

|Total bond interest expense |$4,143,552 |

Problem 15-2A

Part 4

|Semiannual |Unamortized Discount |Carrying Value |

|Period-End | | |

| 1/01/2002 | $543,552 |$3,456,448 |

| 6/30/2002 | 525,434 | 3,474,566 |

|12/31/2002 | 507,316 | 3,492,684 |

| 6/30/2003 | 489,198 |3,510,802 |

|12/31/2003 | 471,080 |3,528,920 |

Part 5

2002

|June 30 |Bond Interest Expense |138,118 | |

| | Discount on Bonds Payable | |18,118 |

| | Cash | |120,000 |

| | To record six months’ interest and | | |

| |discount amortization. | | |

| | | | |

|2002 | | | |

|Dec. 31 |Bond Interest Expense |138,118 | |

| | Discount on Bonds Payable | |18,118 |

| | Cash | |120,000 |

| | To record six months’ interest and | | |

| |discount amortization. | | |

Part 6

[Note: Parts 1 through 5 are repeated assuming a bond premium.]

Requirement 1

2002

|Jan. 1 |Cash |4,895,980 | |

| | Premium on Bonds Payable | |895,980 |

| | Bonds Payable | |4,000,000 |

| | Sold bonds on issue date at a premium. | | |

Requirement 2

(a) Cash Payment = $4,000,000 x 6% x 6/12 = $120,000

(b) Premium = $4,895,980 - $4,000,000 = $895,980

Straight-line premium amortization = $895,980 / 30 semiannual periods

= $29,866

(c) Bond interest expense = $120,000 - $29,866 = $90,134

Requirement 3

|Thirty payments of $120,000 |$3,600,000 |

|Par value at maturity | 4,000,000 |

|Total repaid |$7,600,000 |

|Less amount borrowed | (4,895,980) |

|Total bond interest expense |$2,704,020 |

or:

|Thirty payments of $120,000 |$3,600,000 |

|Less premium | (895,980) |

|Total bond interest expense |$2,704,020 |

Requirement 4

|Semiannual |Unamortized Premium |Carrying Value |

|Period-End | | |

| 1/01/2002 | $895,980 |$4,895,980 |

| 6/30/2002 |866,114 | 4,866,114 |

|12/31/2002 | 836,248 | 4,836,248 |

| 6/30/2003 | 806,382 | 4,806,382 |

|12/31/2003 | 776,516 |4,776,516 |

Requirement 5

2002

|June 30 |Bond Interest Expense |90,134 | |

| |Premium on Bonds Payable |29,866 | |

| | Cash | |120,000 |

| | To record six months’ interest and | | |

| |premium amortization. | | |

| | | | |

|2002 | | | |

|Dec. 31 |Bond Interest Expense |90,134 | |

| |Premium on Bonds Payable |29,866 | |

| | Cash | |120,000 |

| | To record six months’ interest and | | |

| |premium amortization. | | |

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