Question

On January 1, the first day of its fiscal year, Chin Company issued $21,300,000 of five-year, 4% bonds to finance its operations of producing and selling home improvement products. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 5%, resulting in Chin Company receiving cash of $20,367,938.
A. Journalize the entries to record the following (refer to the Chart of Accounts for exact wording of account titles):
1. Issuance of the bonds.
2. First semiannual interest payment. The bond discount is combined with the semiannual interest payment. (Round your answer to the nearest dollar.)
3. Second semiannual interest payment. The bond discount is combined with the semiannual interest payment. (Round your answer to the nearest dollar.)
B. Determine the amount of the bond interest expense for the first year.
C. Explain why the company was able to issue the bonds for only $20,367,938 rather than for the face amount of $21,300,000.

Answer 1

Answer:

cash          20,367,938 debit

discount on bonds payable 932,062 debit

   bonds payable  21,300,000 credit

--to record issuance--

interest expense 509,198.45 debit

discount on BP      83,198.45 credit

cash             426,000.00 credit

--to record first interest payment--

interest expense 511278.41 debit

discount on BP     85278.41 credit

cash            426,000.00 credit

--to record second interest payment

The company raised below the face value as the bond offer a yield lower than the epected for the market if the company try to sell the bonds at their face value it will sale none, as investorwould prefer other option with the similar risk that yield the 5% market rate.

Explanation:

Under the effective method the interest expense is determinate as the carrying value times effective rate:

20,367,938 x 0.025 (semiannual market rate) = 509,198.45

Then, we compare against cash proceeds:

21,300,000 x 0.02 =  426,000

The difference is the amortization on the dicount

Then we repeat the process in the second period but with the updated carrying value of:

20,367,938 + 85278.41 = 20,451,136