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Chapter 14 Troubled Debt Restructuring

1. In a troubled debt restructuring in which the debt is continued with modified terms andthe carrying amount of the debt is less than the total future cash flows,a. a loss should be recognized by the debtor.b. a gain should be recognized by the debtor.

c. a new effective-interest rate must be computed.d. no interest expense or revenue should be recognized in the future.

2. In a troubled debt restructuring in which the debt is continued with modified terms, a gainshould be recognized at the date of restructure, but no interest expense should berecognized over the remaining life of the debt, whenever thea. carrying amount of the pre-restructure debt is less than the total future cash flows.b. carrying amount of the pre-restructure debt is greater than the total future

cash flows.c. present value of the pre-restructure debt is less than the present value of the future

cash flows.d. present value of the pre-restructure debt is greater than the present value of the

future cash flows.

3. In a troubled debt restructuring in which the debt is continued with modified terms andthe carrying amount of the debt is less than the total future cash flows, the creditorshoulda. compute a new effective-interest rate.b. not recognize a loss.c. calculate its loss using the historical effective rate of the loan.d. calculate its loss using the current effective rate of the loan.

Use the following information for questions 4 through 6:

On December 31, 2008, Nolte Co. is in financial difficulty and cannot pay a note due that day. Itis a $600,000 note with $60,000 accrued interest payable to Piper, Inc. Piper agrees to acceptfrom Nolte equipment that has a fair value of $290,000, an original cost of $480,000, andaccumulated depreciation of $230,000. Piper also forgives the accrued interest, extends thematurity date to December 31, 2011, reduces the face amount of the note to $250,000, andreduces the interest rate to 6%, with interest payable at the end of each year.

4. Nolte should recognize a gain or loss on the transfer of the equipment ofa. $0.b. $40,000 gain.c. $60,000 gain.d. $190,000 loss.

$ 480,000-$230,000= $250,000 cost basis. FV of equipment is $ 290,000 thus $ 40,000 gain.

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5. Nolte should recognize a gain on the partial settlement and restructure of the debt ofa. $0.b. $15,000.c. $55,000.

d. $75,000.

($ 600,000 debt + $ 60,000 accrued interest) ($ 290,000 FV of equipment +$250,000 note +accrued interest of $ 45,000 on new note). Interest on new note= $ 250,000 x 6% x 3 years.

6. Nolte should record interest expense for 2011 ofa. $0. Effective Interest rate is 0.b. $15,000.c. $30,000.d. $45,000.

7. Eddy Co. is indebted to Cole under a $400,000, 12%, three-year note datedDecember 31, 2009. Because of Eddy's financial difficulties developing in 2011, Eddyowed accrued interest of $48,000 on the note at December 31, 2011. Under a troubleddebt restructuring, on December 31, 2011, Cole agreed to settle the note and accruedinterest for a tract of land having a fair value of $360,000. Eddy's acquisition cost of theland is $290,000. Ignoring income taxes, on its 2011 income statement Eddy shouldreport as a result of the troubled debt restructuring

Gain on Disposal Restructuring Gaina. $158,000 $0b. $110,000 $0

c. $70,000 $40,000d. $70,000 $88,000

Gain on disposal: $360,000 FV- $290,000 Cost of LandRestructuring Gain: $400,000 Debt+ $ 48,000 accrued interest- $ 360,000 FV of Land

8. Accounting for a troubled debt settlement.

Ludwig, Inc., which owes Giffin Co. $800,000 in notes payable, is in financial difficulty. Toeliminate the debt, Giffin agrees to accept from Ludwig land having a fair market value of$610,000 and a recorded cost of $450,000.

Instructions(a) Compute the amount of gain or loss to Ludwig, Inc. on the transfer (disposition) of the land.

(b) Compute the amount of gain or loss to Ludwig, Inc. on the settlement of the debt.

(c) Prepare the journal entry on Ludwig 's books to record the settlement of this debt.

(d) Compute the gain or loss to Giffin Co. from settlement of its receivable from Ludwig.

(e) Prepare the journal entry on Giffin's books to record the settlement of this receivable.

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Solution

(a) Fair market value of the land $610,000Cost of the land to Ludwig, Inc. 450,000

Gain on disposition of land $160,000

(b) Carrying amount of debt $800,000Fair market value of the land given 610,000Gain on settlement of debt $190,000

(c) Notes Payable ............................................................................. 800,000Land ................................................................................ 450,000Gain on Disposition of Land ............................................. 160,000Gain on Settlement of Debt .............................................. 190,000

(d) Carrying amount of receivable $800,000Land received in settlement 610,000Loss on settled debt $190,000

(e) Land ............................................................................................ 610,000Allowance for Doubtful Accounts ................................................. 190,000

Notes Receivable ............................................................. 800,000

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CHAPTER 14 LONG TERM LIABILITIES- TIPS ON BONDS

1. The denomination of a bond is called the face value. Synonymous terms are par value, principal

amount, maturity value and face amount.

2.

Bond prices are quoted in terms of percentage of par. Thus bond with a par value of $ 4,000

and a price quote of 102 is currently selling for a price of $ 4,080 (102 x $ 4,000). A bond with a

quote of 100 is selling at par or face value.

3. The bond contract is called an indenture. This term is often confused with the term debenture.

A debenture bond is an unsecured bond.

4. The interest rate written in the bond indenture and ordinarily appearing on the bond certificate

is known as the stated rate. Synonymous terms are: coupon rate, nominal rate and contract

rate.

5. The rate of interest actually earned by bondholders is called the effective, yield or market rate.

6. A bonds issuance price is determined by the present value of all of the future cash flows

promised by the bond indenture. The future cash flows include the face value and interest

payments. The bonds present value is determined by using the market rate of interest at the

date of issuance. An excess of the issuance price over par is called a premium; an excess of par

value over issuance price is called a discount.

7. In computing the present value of a bonds (1) maturity value and (2) interest payments, the

same interest rate is used. That rate is the effective interest rate on a per interest period basis.

Example: If a ten year bond has a state rate of 10%, pays interest semiannually, and is issued to

yield 12%, a 6% rate is used to perform all of the present value calculations.

8. Bond prices vary inversely with changes in the market rate of interest. This means :

As the market rate of interest goes down, bond prices go up.

As the market rate of interest goes up, bond prices go down.

This also means that at the date of issuance:

If the market rate of interest is below the state rate, the price will be above par.

If the market rate of interest is above the stated rate, the price will be below par.

Thus, a premium or a discount is an adjustment to interest via an adjustment to price. The

adjustment to interest is recorded by the process of amortizing the premium or discount over

the periods the bond is outstanding.

9.

Interest payments on notes payable are generally made on a monthly or quarterly basis.Interest payments on bonds payable are usually made semiannually. Despite these practices

interest rates generally are express on an annual basis. Therefore care must be taken that the

annual rate be converted to a rate per period before other computations are performed.

10.The Discount on Bonds Payableis a contra liability account so its balance should be deducted

from Bonds Payable on the balance sheet. The Premium on Bonds Payableaccount is an

adjunct type of valuation account so that its balance is added to Bonds Payable on the balance

sheet. Unamortized Bond Issuance Costs are to be classified as a deferred charge in the other

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assets classification on the balance sheet; they should be amortized over the bonds life using

the straight line method.

11.The effective interest method of amortization is sometimes called the interest method or the

present value method or the effective method. When the effective interest method is used, the

bonds carrying value will equal its present value (assuming amortization is up to date). The

effective interest method is the only amortization method that qualifies as GAAP. However,

when the results of applying the straight- line method of amortization are not materially

different than the results of using the effective interest method, the straight-line method maybe used without being considered a departure (a violation) of GAAP.

12.When the accounting period ends on a date other than an interest date, the amortization

schedule for a bond or a note payable is unaffected by this fact. That is, the schedule is

prepared and computations are made according to the bond periods, ignoring the details of the

accounting period. The interest expense amounts shown in the amortization schedule are then

apportioned to the appropriate accounting period.

EXAMPLE: If the interest expense for the six months ending April 30, 2008 is $ 120,000,

then $ 40,000 (2/6) of that amount would appear on the income statement for the 2007

calendar year and $ 80,000 (4/6) should be reflect on the income statement for the 2008

calendar year.

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Chapter 14 Bond Prices and Interest Rates:

Facts: Three year bonds are issued at face value of $ 100,000 and a stated rate of interest of 12%.

1. If the bonds are issued to yield 10%, what is the selling price of the bond?

PV of $100,000 (Table 6-2-PV of a $1) x .75132 = $ 75,132

PV of Interest Payments (Table 6-4-PV of Ordinary Annuity)

$ 100,000 x 12% = $ 12,000 annual interest x 2.48685 = $ 29,842

Selling Price of Bonds $104,974

Were the bonds sold at a premium or a discount and what is the journal entry to record the transaction?

Because the stated rate is higher than the effective(also referred to as market or yield rate), bonds are

sold at a premium.

Cash $ 104,974

Bonds Payable $ 100,000

Premium 4,974

2. If the bonds are issued to yield 12%, what is the selling price of the bond?

PV of $ 100,000 (Table 6-2) $ 100,000 x .71178 = $ 71,178

PV of Interest Payments (Table 6-4)

$ 100,000 x 12% = $ 12,000 interest x 2.40183 = $ 28,822

Selling Price of bonds at par = $ 100,000

Were the bonds sold at a premium or discount and what is the journal entry to record the transaction?

Bonds were sold at par since the market(yield or effective) rate equals the stated rate of 12%.

Cash $ 100,000


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3. If the bonds were issued to yield 15%, what is the selling price of the bond?

PV of $ 100,000 ( Table 6-2) $ 100,000 x .65752 = $ 65,752

PV of Interest Payments ( Table 6-4)

$ 100,000 x 12% = $ 12,000 interest payments x 2.40183 = $ 27,399

Selling price of bonds = $ 93,151

Were the bonds sold at a premium or discount and what is the journal entry to record the transaction?

Bonds were sold at a discount-since market(effective or yield) rate is higher than stated rate, we

must discount the bonds in order to get people wanting to buy them.

Cash $ 93,151

Discount 6,849


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Chapter 14 Bond Problems including Accrued Interest with Solutions

1. On March 31, 2009, Hanson Corporation sold $7,000,000 of its 8%, 10-year bonds for $6,730,500including accrued interest. The bonds were dated January 1, 2009. Interest is paid semiannually onJanuary 1 and July 1. On April 1, 2013, Hanson purchased 1/2 of the bonds on the open market at 99 plusaccrued interest and canceled them. Hanson uses the straight-line method for amortization of bondpremiums and discounts.

(a) What was the amount of the gain or loss on retirement of the bonds?

1. Determine amount of interest included in $ 6,730,500 purchase price.

($7,000,000 .08 3/12) = Accrued interest at Date Bond sold or $140,000

Thus the bond itself sold for $ 6,590,500

2. Determine premium or discount

Face of Bonds $7,000,000

Bond Price $6,590,500

Discount at 3/31/09 409,500

3. Determine amortization

This was a 10 year bond = 10 x 12 = 120 months3 months have lapsed prior to sale = 3 monthsRemaining months to amortize = 117 months

Monthly amortization = $409,500 / 117 = $3,500 per month

How many months have passed until 4/1/2013? 48Thus the amortization to 4/1/13 = $3,500 x 48 months = $168,000

Original Discount at Date of Sale = $ 409,500Less amortization taken = $ 168,000Unamortized discount at 4/1/13 = $ 241,500

Carrying value at 4/1/13 = $ 6,758,500

Carrying value of 1/2 of the bonds $ 3,379,250Less acquisition price ($7,000,000 .99 1/2) 3,465,000Loss on retirement $ 85,750

Journal Entry when bonds are sold on March 31, 2009:

Cash $6,730,500Discount 409,500

Bonds Payable $7,000,000Interest Expense (or Interest Payable) 140,000

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(b) Prepare the journal entry needed at April 1, 2013 to record retirement of the bonds. Assume thatinterest and premium or discount amortization have been recorded through January 1, 2013. Recordinterest and amortization on only the bonds retired.

Interest Expense .................................................................... 75,250Discount on Bonds Payable ($1,750 3) ...................... 5,250Cash ............................................................................. 70,000

(To accrue interest to 4/1/13:

$7,000,000 .08 3/12 1/2 = $70,000)

This entry is to accrue the interest expense for January 1, 2013 to April 1, 2013 and pay the cash owedto the bondholder-he is entitled to the cash at date bond is retired.

Bonds Payable .................................................................. 3,500,000Loss on Redemption of Bonds .................................................. 85,750

Discount on Bonds Payable ($241,500 1/2) ................ 120,750Cash ............................................................................. 3,465,000

(To remove carrying value of bonds)

(c) Prepare the journal entry needed at July 1, 2013 to record interest and premium or discountamortization.

Interest Expense ...................................................................... 150,500Discount on Bonds Payable .......................................... 10,500Cash ............................................................................. 140,000

(Discount amortization:$409,500 117 mos. 6 mos. 1/2 = $10,500)

Remember this is for the bonds that remain-it is not advised for purposes of this class to redo your scheduleJust remember only of bond remain.

2. On January 1 of the current year, Feller Corporation issued $3,000,000 of 10% debenture bonds on a basisto yield 9%, receiving $3,134,580. Interest is payable annually on December 31 and the bonds mature in 6years. The effective-interest method is used.

(a) What is the interest expense for the first year?

First year interest expense:

$3,134,580 .09 = $282,112

(b)What is the interest expense for the second year?

Second year interest expense:

$300,000 $282,112 = $17,888 Premium amortization (First year).

$3,134,580 $17,888 = $3,116,692 Book value of bonds at the beginning of the second year.

$3,116,692 .09 = $280,502 Interest expense.

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3. On October 1, 2012, Noller Company issued $4,000,000 par value, 10%, 10-year bonds dated July 12012, with interest payable semiannually on January 1 and July 1. The bonds are issued at $4,542,000 (toyield 8%) plus accrued interest. The effective interest method is used.

(a) Prepare the journal entry at the date the bonds are issued.

Cash .................................................................................. 4,642,000

Bonds Payable ............................................................. 4,000,000Premium on Bonds Payable ......................................... 542,000Interest Payable ........................................................... 100,000

(b) Prepare the adjusting entry at December 31, 2012, the end of the fiscal year.

Interest Expense ............................................................................ 90,840Premium on Bonds Payable ..................................................... 9,160

Interest Payable ........................................................... 100,000

(Interest expense: $4,542,000 .08 3/12 = $90,840)

(c) Prepare the entry for the interest payment on January 1, 2013.

Interest Payable ...................................................................... 200,000Cash ............................................................................. 200,000

4. Prepare journal entries to record the following transactions related to long-term bonds of Quirk Co.

(a) On April 1, 2011, Quirk issued $1,000,000, 9% bonds for $1,075,736 including accrued interest. Interest ispayable annually on January 1, and the bonds mature on January 1, 2021.

Cash.............................................................................................. 1,075,736Bonds Payable .................................................................... 1,000,000Interest Expense ($1,000,000 9% 3/12) ........................ 22,500Premium on Bonds Payable ................................................ 53,236

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(b) On July 1, 2013 Quirk retired $300,000 of the bonds at 102 plus accrued interest. Quirk uses straight-lineamortization.

1. Amortize bond to date of retirement.

Interest Expense ........................................................................... 12,680Premium on Bonds Payable ($53,236 .3 6/117) ...................... 820

Cash ($300,000 9% 6/12) ............................................. 13,500

This entry amortizes the bond to the date of retirement and pays the bondholder the interest he is owed incash. This also brings the Income Statement to the correct amount of interest expense incurred for the periodto the date of retirement.

Note: This was a 10 year bond but it was not sold until the 3 months after the date 9( assumed since it matureson January 1, 2021. Maturity is on the same date as original bond date but in the future. Thus for amortizationpurposes we only have 117 months remaining at date bond is sold until it matures.

2. Retire the portion of the bond and its related accounts to determine gain or loss.

Bonds Payable .............................................................................. 300,000Premium on Bonds Payable ($53,236 .3 90/117) .................... 12,284

Cash ................................................................................... 306,000Gain on Redemption of Bonds ............................................ 6,284

Here we determined the number of months remaining to amortize by determining the months that havelapsed (quick short cut).

2011 9 months2012 12 months2013 6 months

Total 27 months

5. A company issues $5,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007. Interest is paidon June 30 and December 31. The proceeds from the bonds are $4,901,036. Using effective-interestamortization, what will the carrying value of the bonds be on the December 31, 2007 balance sheet?a. $4,903,160b. $5,000,000c. $4,906,281d. $4,902,077

Cash Interest Effective/YieldInterest

Amortization Carrying Value

4,901,036195,000 196,041 1,041 4,902,077195,000 196,083 1,083 4,903,160

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6. On January 1, 2001, Gonzalez Corporation issued $4,500,000 of 10% ten-year bonds at 103. Thebonds are callable at the option of Gonzalez at 105. Gonzalez has recorded amortization of the bondpremium on the straight-line method (which was not materially different from the effective-interestmethod).

On December 31, 2007, when the fair market value of the bonds was 96, Gonzalez repurchased$1,000,000 of the bonds in the open market at 96. Gonzalez has recorded interest and amortization for2007. Ignoring income taxes and assuming that the gain is material, Gonzalez should report thisreacquisition as

a. a loss of $49,000.b. a gain of $49,000.c. a loss of $61,000.d. a gain of $61,000.

Carrying Value at Date of Issue = $ 4,500,000 x 1.03= $ 4,635,000Thus we have a Premium of $135,000.Straight Line amortization for 10 years = $1,125 per month

At date bonds are acquired in the open market determine the carrying value of the entire bond issue asof 12/31/07.

Bond Payable $ 4,500,000Plus remaining Bond Premium $1,125 x 36 months remaining 40,500Carrying Value of Entire Bond $4,540,500

What percentage of bonds are being retired? 22.22 % ($1,000,000/ $4,500,000)

Thus the CV is $ 1,009,000 for bonds repurchased as of 12/31/07. ($4,540,500 x.22222) and rounded.

To determine gain or loss:

Bonds Payable 1,000,000Bond Premium 9,000

Cash 960,000 ($1,000,000 x .96)Gain on Sale 49,000

7. Goebel Company issues $5,000,000 face value of bonds at 96 on January 1, 2006. The bonds aredated January 1, 2006, pay interest semiannually at 8% on June 30 and December 31, and mature in10 years. Straight-line amortization is used for discounts and premiums. On September 1, 2009$3,000,000 of the bonds are called at 102 plus accrued interest. What gain or loss would be recognizedon the called bonds on September 1, 2009?a. $300,000 lossb. $136,000 lossc. $180,000 lossd. $226,667 loss

Bonds issued at $4,800,000 ($5,000,000 face x .96)Thus there is a $ 200,000 discountStraight line amortization would be for 120 months or $1,666.67 per month

Amortize bond to date of call:Carrying Value at date bond is issued: $ 4,800,000

Amortization to 9/1/2009 73,333 ($1,666.67 x 44 months)Carrying Value at 9/1/09 $ 4,873,333

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What percentage of bonds are being called? 60% ($3,000,000/$5,000,000)Carrying value to be removed: $4,873,333 x 60% = $ 2,923,999.80 or $2,924,000 rounded.Journal Entry:

Bonds Payable 3,000,000Loss on Retirement 136,000

Discount on Bonds 76,000Cash 3,060,000 ($3,000,000 x 1.02)

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Chapter 14 Bonds Class Problems

1. On April 1,2006, Holiday Brands issued $ 30 million of 6% , 30 year bonds, dated January 1, 2006

for $ 27.5 million, plus accrued interest. What was the amount of accrued interest that was

included in the proceeds received from the bond issue?

2. A company issued 5% , 20 year bonds with a face amount of $ 80 million. The market yield for

bonds of similar risk and maturity is 6%. Interest is paid semiannually. At what price did thebonds sell?

3.

A company issued 6%, 15 year bonds with a face amount of $ 75 million, The market yield for

bonds of similar risk and maturity is 6%. At what price did the bonds sell, if interest is paid

semiannually?

4. A company issued 5%, 20 year bonds with a face amount of $ 100 million. The market yield for

bonds of similar risk and maturity is 4%. Interest is paid semiannually. At what price did the

bonds sell?

5. On January 1, a company issued 7%, 15 year bonds with a face amount of $ 90 million for

$ 82,218,585 to yield 8%. Interest is paid semiannually. What was the interest expense at the

effective interest rate on the December 31 annual income statement?

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2

6. On January 1, a company issued 3% , 20 year bonds with a face amount of $ 80 million for

$ 69,033,776 to yield 4%. Interest is paid semiannually. What was the interest expense at the

effective interest rate on the December 31 income statement?

7. On January 1, a company issued 3% , 20 year bonds with a face amount of $ 80 million for

$ 69,033,776 to yield 4%. Interest is paid semiannually. What was the interest expense using

the straight line method on the December 31 income statement?

8. On January 1, 2007, Oak Co. issued 400 of its 8%, $ 1,000 bonds at 97 plus accrued interest. The

bonds are dated October 1, 2006, and mature on October 1, 2012. Interest is payable

semiannually on April 1 and October 1. Accrued interest for the period October 1, 2006 to

January 1, 2007 amounted to $ 8,000. On January 1, 2007, what amount should Oak report as

bonds payable net of discount?

a. $ 380,000

b. $ 388,000

c. $ 388,300

d. $ 392,000

9 A bond issued on June 1, 2006 has interest payment dates of April 1 and October 1. Bondinterest expense for the year ended December 31, 2006 is a for a period of:

a. 3 months

b.

4 months

c. 6 months

d. 7 months

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Chapter 14-Class Problems Solution

1. Holiday Brands Problems

$30,000,000 x 6% x 3/12 = $450,000

face annual fraction of the accruedamount rate annual period interest

2.

Interest $ 2,000,000 x 23.11477* = $46,229,540

Principal $80,000,000 x 0.30656** = 24,524,800

Present value (price) of the bonds $70,754,340 [52] % x $80,000,000

* present value of an ordinary annuity of $1: n=40, i=3%** present value of $1: n=40, i=3%

3.

The price will be the present value of the periodic cash interest payments (face amount xstated rate) plus the present value of the principal payable at maturity. Both interest and

principal are discounted to present value at the market rate of interest for securities of similar riskand maturity. When the stated rate and the market rate are the same, the bonds will sell at facevalue, $75 million in this instance.

4.

Interest $ 2,500,000 x 27.35548* = $ 68,388,700

Principal $100,000,000 x 0.45289** = 45,289,000

Present value (price) of the bonds $113,677,700

[52] % x $100,000,000

* present value of an ordinary annuity of $1: n=40, i=2%** present value of $1: n=40, i=2%

5.

Interest will be the effective rate times the outstanding balance:

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Cash Interest Effective Interest Amortization Carrying Value

1/1 $82,218,585

6/30 3,150,000 3,288,743 138,743 $ 82,357,328

12/31 3,150,000 3,294,293 144,293 $ 82,501,621

Interest per Income Statement for year of issuance = $ 6,583,036

Cash Flow Statement Interest = $ 6,300,000

How would your answer change is Interest was not paid until January 1 of the next week? Interest for income

statement would not change but for first year of statement of cash flows, there would only be $ 3,150,000 .

6.

Interest will be the effective rate times the outstanding balance:

June 30Interest expense (2% x $69,033,776) ..................................... 1,380,676

Discount on bonds payable (difference) ............................ 180,676Cash (1.5% x $80,000,000) ............................................... 1,200,000

December 31

Interest expense (2% x [$69,033,776 + 180,676]) ................. 1,384,289Discount on bonds payable (difference) ............................ 184,289Cash (1.5% x $80,000,000) ............................................... 1,200,000

$1,380,676 + 1,384,289 = $2,764,965

7.

Interest will be a plug figure:

$80,000,000 - 69,033,776 = $10,966,224 discount

$10,966,224 / 40 semiannual periods = $274,156 reduction each period

June 30Interest expense (to balance) .................................................. 1,474,156


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December 31Interest expense (to balance) .................................................. 1,474,156


$1,474,156 + 1,474,156 = $2,948,3128. b

9. d

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CHAPTER 14 BONDS EXTRA QUESTIONS SOLUTIONS

Problem 1 Arnold Howell and Company

a.$ 100, 000 par value x 7% stated rate = $ 7,000 annual cash interest

Factor for PV of single sum, I = 10% ; n= 3 .75132

Factor for PV of an ordinary annuity i=10%, n= 3 2.48685

$ 100,000 x .75132 = $ 75,132.00$ 7,000 x 2.48685= $ 17,407.95

Issue Price $ 92,539.95

Face Value $ 100,000.00

Issue Price $ 92,539.95

Discount $ 7,460.05

b. Cash ( $ 92,539.95- $ 8,000) $ 84,539.95

Discount on bonds payable $ 7,460.05

Bond Issue Costs $ 8,000.00


c. Date 7% Stated 10% Effective Amortization Carrying Value

1/1/07 $ 92,539.95

1/1/08 $ 7,000 $ 9,254.00 $ 2,254.00 $ 94,793.95

1/1/09 $ 7,000 $ 9,479.40 $ 2,479.40 $ 97,273.35

1/1/10 $ 7,000 $ 9,726.65* $ 2,726.65 $ 100,000.00* includes rounding error of .69

Note: Stated interest is determined by multiplying the par value (face value) of the bonds of $ 100,000 by the contract or stated rate

of interest (7%). Interest expense is computed by multiplying the carrying value at the beginning of the interest period by the

effective rate (10%). The amount of discount amortization for the period is the excess of the interest expense over the stated

interest (cash interest) amount. The carrying value at an interest payment date is the carrying value at the beginning of the interest

period plus the discount amortization for the period.

Helpful Hints:

1. The amount of interest expense of $ 9479.40 appearing on the 1/1/09 payment line is the amount of interest expense for

the interest period ending on that date. Thus, in this case, $ 9,479.40 is the interest expense for the 12 months preceding

the date 1/1/09, which would be the calendar year 2008.

2.

Any rounding error should be plugged to(included in) the interest expense amount for the last interest period. Otherwise,

there would forever be a small balance left in the Discount for Bonds Payable account long after the bonds were

extinguished.

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3. Notice that the total interest expense ($ 28,460.05) over the 3 year period equals the total cash interest ($21,000) plus the

total issuance discount ( $ 7,460.05) . Thus you can see that the issuance discount represents an additional amount of

interest to be recognized over the life of the bonds.

d. December 31, 2007

Bond Interest Expense $ 9,254.00

Interest Payable $ 7,000

Discount of Bonds Payable $ 2,254.00

Bond Issue Expense $ 2,666.67 ( $ 8,000 / 3 years)

Unamortized Bond Issue Costs $ 2,666.67

January 1, 2008

Interest Payable $ 7,000

Cash $ 7,000

December 31, 2008Bond Interest Expense $ 9,479.40

Interest Payable $ 7,000.00

Discount on Bonds Payable $ 2,479.40

Bond Issue Expense $2,666.67

Unamortized Bond Issue Costs $2,666.67

e. January 1, 2009


Bonds Payable $ 100,000.00Loss on Redemption of Bonds $ 7,393.31



Cash( $ 102,000 + $ 7,000) $ 109,000.00

( $ 7,460.05- $ 2,254.00-$ 2,479.40= $ 2,762.65 unamortized discount)

( $ 8,000.00- $ 2,666.67-$ 2,666.67= $ 2,666.66 unamortized issue costs)

( $ 100,000x 102% = $ 102,000 price to retire)

( $ 100,000- $ 2,726.65= $ 97,273.35 carrying value)

( $ 97,273.36-$ 2,666.66= $ 94,606.69 net carrying value)

($ 102,000- $ 94,606.69= $ 7,393.31 loss)

Hint: There was a call premium ( amount in excess of par required) of $ 2,000.00 in this situation which is included in

the loss computation.

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Gains or losses on extinguishment of debt were formerly classified as extraordinary items on the income statement

because of the guidelines contained in SFAS No. 4. A few years ago, the FASB eliminated extraordinary treatments for

extinguishments in response to concerns that such gains or losses are neither unusual or infrequent. These gains or

losses are not to be classified as Other Gains and Losses on the Income Statement.

The debit to interest payable (for interest accrued last period) assumes that reversing entries are not made.

Straight Line vs Effective Interest Methods

Tip: Regardless of whether the straight-line method or the effective interest method of amortization is used, the

following will occur:

1. The amount of cash interest (stated interest) is a constant amount each period.

2.

The bonds carrying amount increases over the bonds life if it is issued at a discount, due to the amortization of

the discount.

3. The bonds carrying amount decreases over the bonds life if it is issued at a premium, due to the amortization

of the premium.

Tip: If the straight-line method of amortization is used, the following relationships exist:1. The amount of amortization is a constant amount each period.

2. The amount of interest expense is a constant amount each period.

Tip: If the effective interest method is used, the following relationships exist:

1.

The effective interest rateis constant each period.

2.

The interest expense is an increasing amount each period if the bond is issued at a discount( because a constant

rate is applied to an increasing carrying amount each period).

3. The interest expense is a decreasing amount each period if the bond is issued at a premium( because a constant

rate is applied to an decreasing carrying amount each period).

4.

The amount of amortization expense increases each period because the difference between the effectiveinterest expense and the cash interest widens each period.

14-2 Peter Pan Tools Corporation

a.

Interest paid on July 1, 2007 ( $ 1,400,000 x 9% x 6/12) $ 63,000

Premium amortized on July 1, 2007 ( $ 56,000 x 2/116) $ (966)

Accrued Interest collected on May 1, 2007( $ 1,400,000 x 9% x 4/12) $ (42,000)

Interest accrued on December 31, 2007 ( $ 1,400,000 x 9% x 6/12 $ 63,000

Premium amortized on December 31, 2007 ( $ 56,000 x 6/116) $ ( 2,897)

Total bond interest expense for the year ending 12/31/2007 $ 80,137

Explanation: Prepare the journal entries to record the issuance of the bonds, the payment of interest and amortization

of premium on July 1, 2007 and the year-end adjusting entry. Post the entries to the interest expense account and

determine its balance at 12/31/2007.

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5/1/2007

Cash $ 1,498,000

Bonds Payable $ 1,400,000

Premium on Bonds Payable $ 56,000

Bond Interest Expense $ 42,000( 104% x $ 1,400,000 - $ 1,400,000 = $ 56,000 premium)

(9% x $ 1,400,000 x 4/12 = $ 42,000 accrued interest for Jan thru April 2007)

( $ 1,456,000 issue price + $ 42,000 accrued interest = $ 1,498,000 cash proceeds)

7/1/07

Bond Interest Expense( $ 63,000- $ 966) $ 62,034

Premium on Bonds Payable( $ 56,000 x 2/116) $ 966

Cash ( $ 1,400,000 x 9% x 6/12) $ 63,000( A premium or discount is to be amortized over the period the bonds are outstanding(from the date of issuance to the date of maturity). In this case, May 1, 2007 to

January 1, 2017 is 4 months shy of 10 years , which is 116 months)

12/31/2007

Bond Interest Expense ( $ 63,000- $ 2,897) $ 60,103

Premium on Bond Payable ( $ 56,000x 6/116) $ 2,897

Bond Interest Payable $ 63,000( $ 1,400,000 x 9% x 6/12) To record accrual of interest since last payment date and amortization of premium for 6 months.

Tip: Bonds are often issued between issued interest payment dates. When this occurs, the issuer requires the investor to pay the market price for

the bonds plus accrued interest since the last interest date. At the next interest payment date, the corporation will return the accrued interest to

the investor by paying the full amount of interest due on outstanding bonds. In the situation at hand, the issuer collects from the investor interest

from the date the bonds are dated to the date of issuance (Jan. 1 to May 1, 2007) which is 4 months. When the next interest date rolls around on

July 1, 2007, a full interest payment is made to the investor. Thus, the investor receives the 2 months interest earned from May 1 to June 30, 2007,

plus the accrued interest for 4 months that the investor paid in at the purchase date. Accrued interest at the date bonds are sold by an issuer is

handled in this manner to expedite the issuers payment procedures. At any interest payment date, interest for a full interest period is paid to each

bondholder, there is no need to compute the actual time the bond investment was held by a particular bondholder and to prorate the interest

because the investor has already paid in any portion of the full interest payment not earned by them during that interest period.

The journal entry to record the 2ndinterest payment on 1/1/2008 would be as follows ( assuming reversing entries are not used)

Bond Interest Payable $ 63,000

Cash $ 63,000

Bond Interest Expense Bond Interest Payable

12/31/07 $ 63,000

62,034 42,000

60,103

80,137

b. Accrued interest payable at 12/31/2007 $ 1,400,000 x 9% x 6/12 = $ 63,000

c. Interest paid on July 1, 2008 ( $ 1,400,000 x 9% x 6/12) $ 63,000

Premium amortized on July1, 2008 ( $ 56,000 x 6/116) ( 2,897)

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Interest accrued on December 31, 2008 ( $ 1,400,000 x 9% x 6/12) $ 63,000

Premium amortized on December 31, 2008 ( $ 56,000 x 6/116) ( 2,897)

Total Bond Interest Expense for 12/31/2008 $ 120,206

14-3 P & J Chase Company

a.

$ 500,000 x .66506= $ 332,530.00 ( PV of single sum, using I = 6%, n = 7)

$ 25,000 x 5.58238= $ 139,559.50 (PV of ordinary annuity using I= 6%, n = 7)Issue Price $ 472,089.50

b. Date Stated Interest 6% Interest Amortization Carrying Value

11/1/07 $ 472,089.50

5/1/08 $ 25,000 $ 28,325.37 $ 3,325.37 $ 475,414.87

11/1/08 $ 25,000 $ 28,524.89 $ 3,524.89 $ 478,939.76

5/1/09 $ 25,000 $ 28,736.39 $ 3,736.39 $ 482,676.15

11/1/09 $ 25,000 $ 28,960.57 $ 3,960.57 $ 486,636.72

5/1/10 $ 25,000 $ 29,198.20 $ 4,198.20 $ 490,834.92

11/1/10 $ 25,000 $ 29,450.10 $ 4,450.10 $ 495,285.02

5/1/11 $ 25,000 $ 29,714.98 $ 4,714.98 $ 500,000.00

Hint: If you round all your computations to the nearest cent, your rounding error will be small. A small ( less than $ 5.00) rounding error provides

some comfort that the amortization schedule is largely correct. A large rounding error (more than $ 10.00) indicates that one or more mistakes are

likely included in the computation within the schedule or in the determination of the starting point (issue price of the debt).

c.

11/1/07

Cash $ 472,089.50



12/31/07


Discount on Bonds Payable $ 1,108.46Interest Payable $ 8,333.33

( $28,325.37 x 2/6 = $ 9,441.79)

( $ 3,325.37 x 2/6 = $ 1,108.46)

( $ 25,000 x 2/6 = $ 8,333.33)

5/1/08 5/1/09

Interest Payable $ 8,333.33 Bond Interest Expense $19,157.59

Bond Interest Expense $ 18,883.58 Interest Payable $ 8,333.33

Discount on Bonds Payable $ 2,216.91 Discount/Bonds Payable $ 2,490.92

Cash $ 25,000.00 Cash $25,000.00

( $28,325.37 - $ 9,441.79 = $ 18,883.58)

( $ 3,325.37- $ 1,108.46= $ 2,216.91)

11/1/08



Cash $ 25,000.00

12/31/08

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14-4 Tuna Fishery

a. Stated Interest = Stated rate of interest x par

$ 7,000 = stated rate of interest x $ 100,000

$ 7,000 / $ 100,000 = 7% or stated rate of interest

b.

Effective interst = Market rate x carrying value at beginning of period

$ 6,252.74= Market rate x $ 104,212.37

$ 6,252.74/$ 104,212.37 = 6% market rate

c.

Cash $ 102,212.37


Bonds Payable $ 100,000.00

Premium on Bonds Payable $ 4,212.37

d. Bond Interest Expense $ 6,160.38Premium on Bonds Payable $ 839.62


Bond Issue Expense $ 400.00

Unamortized Bond Issue Costs $ 400.00

e. Bond issue expense $ 400 ( $ 2,000 / 5 years)


f. Other Assets

Unamortized Bond Issue Costs $ 800

Current Liabilities

Interest Payable $ 7,000Long-term Liabilities

Bonds Payable $ 100,000.00

Unamortized Premium $ 1,833.40

$ 101,833.40

g. $ 101,833.40

Book value is another name for carrying value or carrying amount.

The amount can also be computed by

Carrying amount @ 1/1/09 $ 102,673.02

Amortization for 2009 ( 839.62)

Carrying Value @ 12/31/09 $ 101,833.40

h. Bonds Payable Balance $ 100,000.00

Premium on Bonds Payable $ 1,833.40

Book Value @ 12/31/09 $ 101,833.40

Unamortized issue costs $ (800.00)

Net Book value @ 12/31/09 $ 101,033.40

i. Gain-A gain will result because the retirement price is less than the net carrying value at the date of retirement.

Net Carrying Value @ 1/1/10 $ 101,033.40

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Retirement price $ 100,500.00

Gain on retirement $ 533.40

This gain from retirement of debt should be classified in the Other Gains and Losses section on the Income Statement.

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Problem: Issuing Bond with Accrued Interest

On July 1, 2007, ABC issued 1,000 of its 10% $ 1,000 bonds at 99 plus accrued interest. The bonds are

date April 1, 2007 and mature on April 1, 2017. Interest is payable semiannually on April 1 and October

1. What amount did ABC receive from the bond issue?

Step 1: Bond Payable at Face x Issue Price

$ 1,000,000 x .99 = $ 990,000

Thus the bond was issued at a discount.

Step 2: Compute accrued interest.

$ 1,000,000 x 5% interest for 6 months = $ 50,000 interest payable every 6 months

$ 50,000 x 3/6 = $ 25,000 (Interest has accrued for 3 months-April, May, June)

Step 3: Cash received from bond issue: $ 990,000 + $ 25,000 = $ 1,015,000

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CHAPTER 14 SAMPLE QUESTIONS AND SOLUTIONS

1. When the interest payment dates of a bond are May 1 and November 1, and a bond issueis sold on June 1, the amount of cash received by the issuer will bea. decreased by accrued interest from June 1 to November 1.b. decreased by accrued interest from May 1 to June 1.c. increased by accrued interest from June 1 to November 1.

d. increased by accrued interest from May 1 to June 1.

2. If bonds are initially sold at a discount and the straight-line method of amortization isused, interest expense in the earlier years willa. exceed what it would have been had the effective-interest method of

amortization been used.b. be less than what it would have been had the effective-interest method of

amortization been used.c. be the same as what it would have been had the effective-interest method of

amortiza-tion been used.d. be less than the stated (nominal) rate of interest.

3. An early extinguishment of bonds payable, which were originally issued at a premium, ismade by purchase of the bonds between interest dates. At the time of reacquisitiona. any costs of issuing the bonds must be amortized up to the purchase date.b. the premium must be amortized up to the purchase date.c. interest must be accrued from the last interest date to the purchase date.d. all of these.

On January 1, 2007, Bleeker Co. issued eight-year bonds with a face value of $1,000,000 and astated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds weresold to yield 8%. Table values are:

Present value of 1 for 8 periods at 6% ............................................ .627Present value of 1 for 8 periods at 8% ............................................ .540Present value of 1 for 16 periods at 3% .......................................... .623Present value of 1 for 16 periods at 4% .......................................... .534Present value of annuity for 8 periods at 6% .................................. 6.210Present value of annuity for 8 periods at 8% .................................. 5.747Present value of annuity for 16 periods at 3% ................................ 12.561Present value of annuity for 16 periods at 4% ................................ 11.652

4. The present value of the principal isa. $534,000.b. $540,000.

c. $623,000.d. $627,000.

$1,000,000 .534 = $534,000.

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5. The present value of the interest isa. $344,820.b. $349,560.c. $372,600. ($1,000,000 .03) 11.652 = $349,560.d. $376,830.

6. The issue price of the bonds isa. $883,560.

b. $884,820.c. $889,560.d. $999,600

$534,000 + $349,560 = $883,560.

7. Benton Company issues $10,000,000 of 10-year, 9% bonds on March 1, 2007 at 97 plusaccrued interest. The bonds are dated January 1, 2007, and pay interest on June 30 andDecember 31. What is the total cash received on the issue date?a. $9,700,000b. $10,225,000

c. $9,850,000d. $9,550,000

($10,000,000 .97) + ($900,000 2/12) = $9,850,000.

8. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007.Interest is paid on June 30 and December 31. The proceeds from the bonds are$19,604,145. Using effective-interest amortization, how much interest expense will berecognized in 2007?a. $780,000

b. $1,560,000c. $1,568,498d. $1,568,332

($19,604,145 .04) + ($19,608,310 .04) = $1,568,498.

9. A company issues $5,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007.Interest is paid on June 30 and December 31. The proceeds from the bonds are$4,901,036. Using effective-interest amortization, what will the carrying value of thebonds be on the December 31, 2007 balance sheet?a. $4,903,160b. $5,000,000

c. $4,906,281d. $4,902,077

$4,901,036 + [($4,901,036 .04) $195,000] + [($4,902,077 .04) $195,000]= $4,903,160.

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10. A company issues $5,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2006.Interest is paid on June 30 and December 31. The proceeds from the bonds are$4,901,036. Using straight-line amortization, what is the carrying value of the bonds onDecember 31, 2008?a. $4,917,558b. $4,985,156c. $4,908,458d. $4,915,881

$4,901,036 + ($98,964 3/20) = $4,915,881.

11. On January 1, 2001, Gonzalez Corporation issued $4,500,000 of 10% ten-year bonds at103. The bonds are callable at the option of Gonzalez at 105. Gonzalez has recordedamortization of the bond premium on the straight-line method (which was not materiallydifferent from the effective-interest method).

On December 31, 2007, when the fair market value of the bonds was 96, Gonzalezrepurchased $1,000,000 of the bonds in the open market at 96. Gonzalez has recorded

interest and amortization for 2007. Ignoring income taxes and assuming that the gain ismaterial, Gonzalez should report this reacquisition asa. a loss of $49,000.b. a gain of $49,000.c. a loss of $61,000.d. a gain of $61,000.

$ 4,500,000 x 1.03= $ 4,635,000 CV at date of issue. At December 31, 2007, CV is $1,009,000 for bonds repurchased . Calculated as 135,000 /10 x 3 for years remaining +4.500,000 x .2222.

12. Goebel Company issues $5,000,000 face value of bonds at 96 on January 1, 2006. The

bonds are dated January 1, 2006, pay interest semiannually at 8% on June 30 andDecember 31, and mature in 10 years. Straight-line amortization is used for discounts andpremiums. On September 1, 2009, $3,000,000 of the bonds are called at 102 plus accruedinterest. What gain or loss would be recognized on the called bonds on September 1,2009?a. $300,000 lossb. $136,000 lossc. $180,000 lossd. $226,667 loss

{$4,800,000 + [$200,000 (3 2/3 10)]} .60 = $2,924,000$3,060,000 $2,924,000 = $136,000.

13.Bond issue price and premium amortization.

On January 1, 2007, Lowry Co. issued ten-year bonds with a face value of $1,000,000 and astated interest rate of 10%, payable semiannually on June 30 and December 31. The bondswere sold to yield 12%. Table values are:

Present value of 1 for 10 periods at 10% .................................... .386Present value of 1 for 10 periods at 12% .................................... .322Present value of 1 for 20 periods at 5% ...................................... .377Present value of 1 for 20 periods at 6% ...................................... .312

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Present value of annuity for 10 periods at 10% .......................... 6.145Present value of annuity for 10 periods at 12% .......................... 5.650Present value of annuity for 20 periods at 5% ............................ 12.462Present value of annuity for 20 periods at 6% ............................ 11.470

Instructions(a) Calculate the issue price of the bonds.

(b)Without prejudice to your solution in part (a), assume that the issue price was $884,000.

Prepare the amortization table for 2007, assuming that amortization is recorded oninterest payment dates.

Solution 13

(a) .312 $1,000,000 = $312,00011.470 $50,000 = 573,500

$885,500

(b) Date Cash Expense Amortization Carrying Amount1/1/07 $884,0006/30/07 $50,000 $53,040 3,040 887,040

12/31/07 50,000 53,222 3,222 890,262

14.-Amortization of discount or premium.

Benson Industries, Inc. issued $6,000,000 of 8% debentures on May 1, 2006 and received cashtotaling $5,323,577. The bonds pay interest semiannually on May 1 and November 1. Thematurity date on these bonds is November 1, 2014. The firm uses the effective-interest method ofamortizing discounts and premiums. The bonds were sold to yield an effective-interest rate of10%.

Instructions

Calculate the total dollar amount of discount or premium amortization during the first year(5/1/06 through 4/30/07) these bonds were outstanding. (Show computations and round to the

nearest dollar.)

Solution 14

Interest Cash Discount CarryingDate Expense Interest Amortized Value of Bonds

5/1/06 $5,323,57711/1/06 $266,179 $240,000 $26,179 5,349,7565/1/07 267,488 240,000 27,488 5,377,244

Total $53,667

15.Entries for bonds payable.

Prepare journal entries to record the following transactions relating to long-term bonds of Grier,Inc. (Show computations.)

(a)On June 1, 2006, Grier, Inc. issued $600,000, 6% bonds for $587,640, which includesaccrued interest. Interest is payable semiannually on February 1 and August 1 with thebonds maturing on February 1, 2016. The bonds are callable at 102.

(b) On August 1, 2006, Grier paid interest on the bonds and recorded amortization. Grier usesstraight-line amortization.

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(c) On February 1, 2008, Grier paid interest and recorded amortization on all of the bonds, andpurchased $360,000 of the bonds at the call price. Assume that a reversing entry was madeon January 1, 2008.

Solution 15

(a) Cash ............................................................................................. 587,640Discount on Bonds Payable .............................................................. 24,360

Bonds Payable ...................................................................... 600,000Interest Expense ($600,000 6% 4/12) ............................ 12,000

(b) Interest Expense ($600,000 6% 6/12) + $420 ............................ 18,420Cash ...................................................................................... 18,000Discount on Bonds Payable ($24,360 2/116) .................... 420

(c) Interest Expense ($18,000 + $1,260)................................................ 19,260Cash ...................................................................................... 18,000Discount on Bonds Payable ($24,360 6/116) ................... 1,260

Bonds Payable .................................................................................. 360,000

Loss on Bond Redemption ............................................................... 19,296Discount on Bonds Payable [.6 ($24,360 $4,200)] ....... 12,096Cash ...................................................................................... 367,200

16 A corporation issues bonds with detachable warrants. The amount to be recorded as paid-in capital is preferablya. zero.

b. calculated by the excess of the proceeds over the face amount of the bonds.c. equal to the market value of the warrants.d. based on the relative market values of the two securities involved.

17. Jenks Co.has $2,500,000 of 8% convertible bonds outstanding. Each $1,000 bond isconvertible into 30 shares of $30 par value common stock. The bonds pay interest on January 31and July 31. On July 31, 2007, the holders of $800,000 bonds exercised the conversionprivilege. On that date the market price of the bonds was 105 and the market price of thecommon stock was $36. The total unamortized bond premium at the date of conversion was$175,000. Jenks should record, as a result of this conversion, a

a. credit of $136,000 to Paid-in Capital in Excess of Par.

b. credit of $120,000 to Paid-in Capital in Excess of Par.c. credit of $56,000 to Premium on Bonds Payable.d. loss of $8,000.

$800,000 + ($175,000 .32) (800 30 $30) = $136,000.

18. In 2006, Berger, Inc., issued for $103 per share, 60,000 shares of $100 par valueconvertible preferred stock. One share of preferred stock can be converted into threeshares of Berger's $25 par value common stock at the option of the preferred stockholder.In August 2007, all of the preferred stock was converted into common stock. The market

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value of the common stock at the date of the conversion was $30 per share. What totalamount should be credited to additional paid-in capital from common stock as a result ofthe conversion of the preferred stock into common stock?a. $1,020,000.b. $780,000.c. $1,500,000.d. $1,680,000.

d $6,180,000 (60,000 3 $25) = $1,680,000.

19. On December 1, 2007, Howell Company issued at 103, two hundred of its 9%, $1,000bonds. Attached to each bond was one detachable stock warrant entitling the holder topurchase 10 shares of Howell's common stock. On December 1, 2007, the market valueof the bonds, without the stock warrants, was 95, and the market value of each stockpurchase warrant was $50. The amount of the proceeds from the issuance that should beaccounted for as the initial carrying value of the bonds payable would bea. $193,640.b. $195,700.c. $200,000.d. $206,000.

b($200,000 .95) + (200 $50) = $200,000; $200,000 1.03 = $206,000

$190,000 $206,000 = $195,700.$200,000

20. During 2007, Cartel Company issued at 104 three hundred, $1,000 bonds due in tenyears. One detachable stock warrant entitling the holder to purchase 15 shares of Cartelscommon stock was attached to each bond. At the date of issuance, the market value of thebonds, without the stock warrants, was quoted at 96. The market value of each detachablewarrant was quoted at $40. What amount, if any, of the proceeds from the issuanceshould be accounted for as part of Cartels stockholders' equity?a. $0b. $12,000c. $12,480d. $11,856

c ($300,000 .96) + (300 $40) = $300,000; $300,000 1.04 = $312,000

$12,000

$312,000 = $12,480.$300,000

21Convertible Bonds.

Dahl Co. issued $5,000,000 of 12%, 5-year convertible bonds on December 1, 2006 for$5,020,800 plus accrued interest. The bonds were dated April 1, 2006 with interest payable April1 and October 1. Bond premium is amortized each interest period on a straight-line basis. DahlCo. has a fiscal year end of September 30.

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On October 1, 2007, $2,500,000 of these bonds were converted into 35,000 shares of $15 parcommon stock. Accrued interest was paid in cash at the time of conversion.

Instructions

(a) Prepare the entry to record the interest expense at April 1, 2007. Assume that interestpayable was credited when the bonds were issued (round to nearest dollar).

(b) Prepare the entry to record the conversion on October 1, 2007. Assume that the entry to

record amortization of the bond premium and interest payment has been made.

Solution 21

When bond was sold, the entry would be:

Cash 5,120,800Bond Payable 5,000,000Premium on Bonds Payable 20,800Interest Payable 100,000

At December 31, 2006, the required journal entry is

Interest Expense 50,000Interest Payable 50,000

(a) Interest Payable ............................................................................... 150,000Interest Expense .............................................................................. 148,400Premium on Bonds Payable ............................................................ 1,600

Cash..................................................................................... 300,000

Calculations:Issuance price $5,020,800Par value 5,000,000Total premium $ 20,800

Months remaining 52Premium per month $400Premium amortized (4 $400) $1,600

(b) Bonds Payable ................................................................................. 2,500,000Premium on Bonds Payable ............................................................ 8,400

Common Stock (35,000 $15) ........................................... 525,000Paid-in Capital in Excess of Par.......................................... 1,983,400

Calculations:Premium related to 1/2 of the bonds $10,400 ($20,800 2)Less premium amortized 2,000 [($10,400 52) 10]Premium remaining $ 8,400

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ACG3141-Chap 14

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