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Chapter 14: Q5IFRS (page 772)

Foreman Company issued $800,000 of 10%, 20-year bonds on January 1, 2017, at 119.792 to yield 8%. Interest is payable semi-annually on July 1 and January 1. Prepare the journal entries to record (a) the issuance of the bonds, (b) the payment of interest and the related amortization on July 1, 2017, and (c) the accrual of interest and the related amortization on December 31, 2017. (Round to the nearest dollar.)

Short Answer

Expert verified
  1. Premium on bond payable totals$158,336.
  2. Premium of$1,666 will be amortized on 1 July 2017.
  3. On December 31 2017 there was an accrual of interest expenses of$38,267.

Step by step solution

01

Definition of Bonds Payable

Bonds payable can be defined as the security issued by the business entity for generating cash for the business entity. These securities are debt securities.

02

Journal entry for issuance of bonds

Date

Accounts and Explanation

Debit $

Credit $

1 Jan 2017

Cash

$958,336

Bond payable

$800,000

Premium on bond payable

$158,336

03

Journal entry for interest and amortization

Date

Accounts and Explanation

Debit $

Credit $

1 July 2017

Interest expenses

$38,334

Premium on bond payable

$1,666

Cash

$40,000

Working note: Amortization table

Date

Cash interest at the stated rate on bond payable (5%)

Interest expenses at market rate on carrying value (4%)

Premium amortized

Unamortized premium

Bond payable

Carrying value

1 Jan 2017

$158,336

$800,000

$958,336

1 July 2017

$40,000

$38,334

$1,666

$156,670

$800,000

$956,670

31 Dec 2017

$40,000

$38,267

$1,733

$154,937

$800,000

$954,937

04

Accrual of interest and amortization

Date

Accounts and Explanation

Debit $

Credit $

31 Dec 2017

Interest expenses

$38,267

Premium on bond payable

$1,733

Interest payable

$40,000

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Most popular questions from this chapter

McCormick Corporation issued a 4-year, \(40,000, 5% note to Greenbush Company on January 1, 2017, and received a computer that normally sells for \)31,495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest.

Part I: The appropriate method of amortizing a premium or discount on issuance of bonds is the effective-interest method.

Instructions

  1. What is the effective-interest method of amortization and how is it different from and similar to the straight-line method of amortization?
  2. How is amortization computed using the effective-interest method, and why and how do amounts obtained using the effective-interest method differ from amounts computed under the straight-line method?

Part II: Gains or losses from the early extinguishment of debt that is refunded can theoretically be accounted for in three ways:

  1. Amortized over remaining life of old debt.
  2. Amortized over the life of the new debt issue.
  3. Recognized in the period of extinguishment

Instructions

  1. Develop supporting arguments for each of the three theoretical methods of accounting for gains and losses from the early extinguishment of debt.
  2. Which of the methods above is generally accepted and how should the appropriate amount of gain or loss be shown in a company’s financial statements?

Question: Will the amortization of Discount on Bonds Payable increase or decrease Bond Interest Expense? Explain.

Presented below are two independent situations.

(a) On January 1, 2017, Robin Wright Inc. purchased land that had an assessed value of \(350,000 at the time of purchase. A \)550,000, zero-interest-bearing note due January 1, 2020, was given in exchange. There was no established exchange price for the land, nor a ready fair value for the note. The interest rate charged on a note of this type is 12%. Determine at what amount the land should be recorded at January 1, 2017, and the interest expense to be reported in 2017 related to this transaction.

(b) On January 1, 2017, Field Furniture Co. borrowed $5,000,000 (face value) from Gary Sinise Co., a major customer, through a zero-interest-bearing note due in 4 years. Because the note was zero-interest-bearing, Field Furniture agreed to sell furniture to this customer at lower than market price. A 10% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2017.

Donald Lennon is the president, founder, and majority owner of Wichita Medical Corporation, an emerging medical technology products company. Wichita is in dire need of additional capital to keep operating and to bring several promising products to final development, testing, and production. Donald, as owner of 51% of the outstanding stock, manages the company’s operations. He places heavy emphasis on research and development and long-term growth. The other principal stockholder is Nina Friendly who, as a nonemployee investor, owns 40% of the stock. Nina would like to deemphasize the R & D functions and emphasize the marketing function to maximize short-run sales and profits from existing products. She believes this strategy would raise the market price of Wichita’s stock.

All of Donald’s personal capital and borrowing power is tied up in his 51% stock ownership. He knows that any offering of additional shares of stock will dilute his controlling interest because he won’t be able to participate in such an issuance. But, Nina has money and would likely buy enough shares to gain control of Wichita. She then would dictate the company’s future direction, even if it meant replacing Donald as president and CEO.

The company already has considerable debt. Raising additional debt will be costly, will adversely affect Wichita’s credit rating, and will increase the company’s reported losses due to the growth in interest expense. Nina and the other minority stockholders express opposition to the assumption of additional debt, fearing the company will be pushed to the brink of bankruptcy. Wanting to maintain his control and to preserve the direction of “his” company, Donald is doing everything to avoid a stock issuance and is contemplating a large issuance of bonds, even if it means the bonds are issued with a high effective-interest rate.

Instructions

(a) Who are the stakeholders in this situation?

(b) What are the ethical issues in this case?

(c) What would you do if you were Donald?
See all solutions

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