Question

Smiley Corporation wholesales repair products to equipment manufacturers. On April 1, 20Y1, Smiley issued $1,400,000 of 4-year, 7% bonds at a market (effective) interest rate of 6%, receiving cash of $1,449,138. Interest is payable semiannually on April 1 and October 1.
Required:
A. Journalize the entries to record the following. Refer to the Chart of Accounts for exact wording of account titles.
1. Issuance of bonds on April 1.
2. First interest payment on October 1 and amortization of bond premium for six months, using the straight-line method. The bond premium amortization is combined with the semiannual interest payment. (Round to the nearest dollar.)
B. Explain why the company was able to issue the bonds for $20,811,010 rather than for the face amount of $20,000,000.

Answer 1

Answer:

A1.Apr.1

Dr Cash $1,449,138

Cr Premium on Bonds Payable $49,138

Cr Bonds Payable $1,400,000

A2. Oct. 1

Dr Interest Expense $24,431

Dr Premium on Bonds Payable $24,569

Cr Cash $49,000

B. The BONDS was paying HIGHER INTEREST RATE of 7% to the MARKET INTEREST RATE of 6%.

Explanation:

A1. Preparation of the journal entry to record Issuance of bonds on April 1Apr.1

Dr Cash $1,449,138

Cr Premium on Bonds Payable $49,138

($1,449,138-$1,400,000)

Cr Bonds Payable $1,400,000

(To record Issuance of bonds)

A2. Preparation of the journal entry to record First interest payment on October 1 and amortization of bond premium for six months, using the straight-line method.

Oct. 1

Dr Interest Expense $24,431

($49,000-$24,569)

Dr Premium on Bonds Payable $24,569

[($1,449,138-$1,400,000)4*2]

Cr Cash $49,000

( $1,400,000 x 7% x 6/12)

(To record First interest payment and amortization of bond premium )

B. Based on the information given the reason

WHY the company was able to issue the bonds for $20,811,010 RATHER THAN for the FACE AMOUNT of $20,000,000 was because the BONDS was paying HIGHER INTEREST RATE of 7% to the MARKET INTEREST RATE of 6%.