Answer:
1. Journalize the entry to record the amount of cash proceeds from the issuance of the bonds on July 1, Year 1.
Dr Cash 37,282,062
Dr Discount on bonds payable 2,717,938
Cr Bonds payable 40,000,000
2. Journalize the entries to record the following:*A. The first semiannual interest payment on December 31, Year 1, and the amortization of the bond discount, using the straight-line method.
Dr Interest expense 1,535,897
Cr Cash 1,400,000
Cr Discount on bonds payable 135,897
B. The interest payment on June 30, Year 2, and the amortization of the bond discount, using the straight-line method.
Dr Interest expense 1,535,897
Cr Cash 1,400,000
Cr Discount on bonds payable 135,897
3. Determine the total interest expense for Year 1.
Interest expense 1,535,897
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 bond's interest rate is lower than the market rate, the bonds will be sold at a discount (less than face value). The market rate applicable to this bond issuance is the one used for similar bonds, so the market rate can change depending on the bond.
5. Compute the price of $37,282,062 received for the bonds by using the present value tables
the value of the bonds = PV of face value + PV of coupons
- PV of face value = $40,000,000 / (1 + 4%)²⁰ = $18,255,478
- PV of annuity = $1,400,000 x PV annuity 4% for 20 periods = $1,400,000 x 13.59033 = $19,026,462
total value = $18,255,478 + $19,026,462 = $37,281,940
There is a small difference, $122, due to rounding errors from the annuity table. But the error is not significant, it represents only 0.0003% of the bonds' price.
Explanation:
issued $40,000,000 of 10-year, 7% bonds at a market (effective) interest rate of 8%, receiving cash of $37,282,062
coupon payment = $40,000,000 x 7% x 1/2 = $1,400,000
semiannual coupon paid December 31 and June 30
Discount on bonds payable $2,717,938 / 20 coupons = $135,896.90 ≈ $135,897 per coupon payment
