1. On July 1, 2010, Harris Co. issued 6,000 bonds at $1,000 each. The bonds paid interest semiannually at 5%. The bonds had a term of 20 years. At the time of issuance, the market rate of interest was 7%. Harris uses the effective interest rate method to amortize bond premium or discount.
a. Calculate the present value of the bonds.
b. Prepare the journal entries to issue the bonds.
c. Prepare the journal entries to amortize the premium or discount as of July 1, 2011.
d. Prepare the journal entries to pay interest due to the bondholders as of January 1 and July 1,
2011.
pv=6,000,000
a. To calculate the present value of the bonds, you need to use the present value formula for a bond. The formula is:
PV = PMT × [1 - (1 + r)^-n] / r + FV / (1 + r)^n
Where:
PV = Present Value
PMT = Periodic interest payment (semiannually)
r = Interest rate per period (semiannually)
n = Number of periods (semiannually)
FV = Face value of the bond
In this case, the PMT will be calculated as 5% of $1,000, which is $50. The interest rate per period (semiannually) is 7% divided by 2, which is 3.5%. The number of periods (semiannually) is 20 years multiplied by 2, which is 40. And finally, the face value (FV) of the bond is $1,000.
Plugging these values into the formula:
PV = $50 × [1 - (1 + 0.035)^-40] / 0.035 + $1,000 / (1 + 0.035)^40
Calculating this equation will give you the present value of the bonds.
b. To prepare the journal entries to issue the bonds, you need to record the issuance of the bonds. The journal entry will include recording the cash received from issuing the bonds and recognizing the bonds payable.
The journal entry will be:
Debit Cash (6,000 bonds × $1,000) for the total amount received.
Credit Bonds Payable for the same total amount.
c. To prepare the journal entries to amortize the premium or discount as of July 1, 2011, you need to calculate the bond premium or discount first. The premium or discount is the difference between the present value of the bond and the face value.
From part a, you have calculated the present value of the bond. The bond's face value is $1,000. Subtracting the face value from the present value will give you the bond premium or discount.
Once you have determined whether it is a premium or discount, you will need to allocate this amount over the remaining life of the bond. Since the bond has a term of 20 years, this process will be repeated over the remaining 19 years.
Each year, you will divide the premium or discount by 40 (the total number of semi-annual periods) to determine the annual amortization amount. Then, you will debit or credit the premium or discount account and amortize it by this amount. The offsetting entry will be to increase or decrease the bond carrying value.
d. To prepare the journal entries to pay interest due to the bondholders as of January 1 and July 1, 2011, you will need to calculate the semiannual interest payment. The payment is 5% of $1,000, or $50.
The journal entry for each interest payment will be:
Debit Interest Expense for $50
Credit Cash for $50
Remember, interest payments are made semiannually, so there will be two separate journal entries for each year.