Question

$600,000 of 7% bonds due in 10 years. The bonds pay interest each July 1 and January 1. Assume an effective interest rate of 8%. Determine the price of the bond and prepare an amortization schedule for two years. What is the interest expense for January 1, 2021

Answer 1

Answer:

the market price of the bonds = present value of face value + present value of coupons:

PV of face value = $600,000 / (1 + 4%)²⁰ = $273,832.17

PV of coupons = $21,000 x 13.590 (annuity factor 4%, n = 20) = $285,390

market price of the bonds = $559,222.17 ≈ I will round down to $559,222

The journal entry to record the issuance of the bonds:

January 1, 2020, bonds are issued

Dr Cash 559,222

Dr Discount on bonds payable 40,778

    Cr Bonds payable

Assuming the effective interest method:

July 1, 2020, first coupon payment

Dr Interest expense 22,369

    Cr Cash 21,000

    Cr Discount on bonds payable 1,369

amortization of discount = ($559,222 x 4%) - $21,000 = $22,369 - $21,000 = $1,369

January 1, 2021, second coupon payment

Dr Interest expense 22,424

    Cr Cash 21,000

    Cr Discount on bonds payable 1,424

amortization of discount = ($560,591 x 4%) - $21,000 = $22,424- $21,000 = $1,424

July 1, 2021, third coupon payment

Dr Interest expense 22,481

    Cr Cash 21,000

    Cr Discount on bonds payable 1,481

amortization of discount = ($562,015 x 4%) - $21,000 = $22,481- $21,000 = $1,481

January 1, 2022, fourth coupon payment

Dr Interest expense 22,540

    Cr Cash 21,000

    Cr Discount on bonds payable 1,540

amortization of discount = ($563,496 x 4%) - $21,000 = $22,540- $21,000 = $1,523

Amortization schedule:

Period      Interest        Bond discount      Interest            Book

                payment      amortization          expense          value

0                                                                                          $559,222

1               $21,000       $1,369                    $22,369          $560,591

2              $21,000       $1,424                    $22,424          $562,015

3              $21,000       $1,481                     $22,481           $563,496

4              $21,000       $1,540                    $22,540          $565,036