On July 1, 2010, Brower Industries Inc. Issued $32,000,000 of 10-year, 12% bonds at an effective interest rate of 13%, receiving cash of $30,237, 139. Interest on the bonds is payable semiannually on December 31 and June 30. The fiscal year of the company is the calendar year.
Instructions:
1. Journalize the entry to record the amount of cash proceeds from the sale of the bonds.
2. Journalize the entry to record the following:
a. The first semiannual interest payment on December 31, 2010, and the amortization of the bond discount, using the straight-line method. (Round to the nearest dollar).
b. The interest payment on June 30, 2011, and the amortization of the bond discounted using the straight-line method. (Round to the nearest dollar).
3. Determine the total interest expensive for 2010.
4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest?
1. The entry to record the amount of cash proceeds from the sale of the bonds would be as follows:
Date: July 1, 2010
Account Title Debit Credit
Cash $30,237,139
Discount on Bonds Payable $1,762,861
Bonds Payable $32,000,000
2a. The entry to record the first semiannual interest payment on December 31, 2010, and the amortization of the bond discount using the straight-line method would be as follows:
Date: December 31, 2010
Account Title Debit Credit
Interest Expense $1,200,000
Discount on Bonds Payable $37,589
Cash $1,162,411
2b. The entry to record the interest payment on June 30, 2011, and the amortization of the bond discount using the straight-line method would be as follows:
Date: June 30, 2011
Account Title Debit Credit
Interest Expense $1,200,000
Discount on Bonds Payable $37,589
Cash $1,162,411
3. The total interest expense for 2010 can be calculated by multiplying the carrying value of the bonds by the effective interest rate. Since the bonds were issued on July 1, 2010, the carrying value would be the face amount of the bonds minus the bond discount.
Carrying value of bonds = Face amount of bonds - Bond discount
Carrying value = $32,000,000 - $1,762,861 = $30,237,139
Total interest expense for 2010 = Carrying value * Effective interest rate
Total interest expense for 2010 = $30,237,139 * 13% = $3,929,524.07 (rounded to nearest dollar as $3,929,524)
4. No, the bond proceeds will not always be less than the face amount of the bonds when the contract rate is less than the market rate of interest. The bond proceeds can be equal to, greater than, or less than the face amount of the bonds, depending on various factors such as the market demand for the bonds, the creditworthiness of the issuer, and prevailing market conditions.
To answer these questions, we need to follow step-by-step instructions. Here's how you can address each question:
1. Journalize the entry to record the amount of cash proceeds from the sale of the bonds:
To record the cash proceeds from the sale of the bonds, you would debit Cash for $30,237,139, and credit Bonds Payable for $32,000,000.
2a. Journalize the entry to record the first semiannual interest payment on December 31, 2010, and the amortization of the bond discount using the straight-line method:
First, calculate the bond discount per period. The total bond discount is $32,000,000 - $30,237,139 = $1,762,861.
The bond discount per period is $1,762,861 / (10*2) = $88,143.
To record the interest payment and bond discount amortization, you would debit Interest Expense for $1,924,143 ($30,237,139 * 13% / 2) and debit Bond Discount Amortization for $88,143. Then, credit Cash for $924,143 ($30,237,139 * 13% / 2) and credit Bonds Payable for $1,100,000 ($88,143 + $1,011,857, which is the total bond discount minus the amortization).
2b. Journalize the entry to record the interest payment on June 30, 2011, and the amortization of the bond discount using the straight-line method:
Using the same calculations as in 2a, you would debit Interest Expense for $1,924,143 and debit Bond Discount Amortization for $88,143. Then, credit Cash for $1,924,143 and credit Bonds Payable for $1,100,000.
3. Determine the total interest expense for 2010:
The total interest expense for 2010 is the interest expense recorded on December 31, 2010. So, the total interest expense for 2010 is $1,924,143.
4. Will the bond proceeds always be less than the face amount of the bonds when the contract rate is less than the market rate of interest?
Yes, when the contract rate (stated interest rate) is less than the market rate of interest, the bond proceeds will be less than the face amount of the bonds. This is because investors are willing to pay less for a bond with a lower contract rate since they can earn a higher return elsewhere in the market.