Bonds issued between interest dates journal entries

Long-Term Liabilities

Chapter 14

Topics you should know after today’s class

How to deal with the accounting valuation for bonds at date of issuance?

Issue at par value, discount, and premium

How to use straight-line method and effective-interest method to amortize discount and premium?

How to deal with bonds issued between interest dates (accrued interest)?

How to amortize cost of issuing bonds?

How to deal with accounting for the extinguishment of debt?

How to do accounting entries for zero-bearing note payable?

How to amortize bonds discount and premium under IFRS?

Long-term debt consist of probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of the company, whichever is longer.

Examples:

Bonds payable

Long-term notes payable

Mortgages payable

Pension liabilities

Lease liabilities

Bonds Payable

Bond contract known as a bond indenture.

Represents a promise to pay:

sum of money at designated maturity date (principal), plus

periodic interest at a specified rate on the maturity amount (face value).

Interest payments usually made semiannually.

Used when the amount of capital needed is too large for one lender to supply.

Issuing Bonds

Stated rate = Rate written in the terms of the bond indenture.

Bond issuer sets this rate.

Stated as a percentage of bond face value (par).

Also known as coupon, or nominal rate

Market rate = Rate that provides an acceptable return commensurate with the issuer’s risk.

Rate of interest actually earned by the bondholders.

Also known as effective yield

Interest Rate

Bonds Sold At

Market Interest

6%

8%

10%

Premium

Par Value

Discount

Valuation of Bonds Payable

Assume Stated Rate of 8%

Buchanan Company issues at par 10-year term bonds with a par value of $800,000, dated January 1, 2014, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the following entry.

Bonds Issued at Par on Interest Date

Journal entry on date of issue, Jan. 1, 2014.

Cash 800,000

Bonds Payable 800,000

Journal entry to record first semiannual interest payment on July 1, 2014.

Interest Expense ($800,000 x .10 x ½) 40,000

Cash 40,000

Journal entry to accrue interest expense at Dec. 31, 2014.

Interest Expense 40,000

Interest Payable 40,000

1. On January 1, 2014, Simon Company issued $193,200 of 9%, 10year bonds at par. Interest is payable quarterly on April 1, July 1, October 1, and January 1.

Prepare journal entries to record the following.

The issuance of the bonds.

The payment of interest on July 1.

The accrual of interest on December 31.

Debit Interest Payable 4,347

Debit Interest Expense 4,347

Credit Interest Payable 4,347

Both B and C are correct

E14-3 (Issue at Par)

Bonds Issued at Discount on Interest Date

If Buchanan Company issues $800,000 (face value) of bonds on January 1, 2014, at 97, and bearing interest at an annual rate of 10 percent (stated rate) payable semiannually on January 1 and July 1, it records the issuance as follows.

Cash ($800,000 x .97) 776,000

Discount on Bonds Payable 24,000

Bonds Payable 800,000

We need to amortize Discount on B/P over the life of B/P.

Assuming the use of the straight-line method

 $1,200 of the discount is amortized to interest expense each period for 20 periods ($24,000 ÷ 20).

Interest Expense 41,200

Discount on Bonds Payable 1,200

Cash 40,000

At Dec. 31, 2014, Buchanan makes the following adjusting entry.

Buchanan records the first semiannual interest payment and the bond discount on July 1, 2014, as follows.

Interest Expense 41,200

Discount on Bonds Payable 1,200

Interest Payable 40,000

Bonds Issued at Discount on Interest Date

Bonds Issued at Premium on Interest Date

If Buchanan Company issues $800,000 of bonds on January 1, 2014, at 103, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1, it records the issuance as follows.

Cash ($800,000 x 1.03) 824,000

Premium on Bonds Payable 24,000

Bonds Payable 800,000

We need to amortize Premium on B/P over the life of B/P.

Assuming the use of the straight-line method

 $1,200 of the premium is amortized to interest expense each period for 20 periods ($24,000 ÷ 20).

Interest Expense 38,800

Premium on Bonds Payable 1,200

Cash 40,000

At Dec. 31, 2014, Buchanan makes the following adjusting entry.

Buchanan records the first semiannual interest payment and the bond premium on July 1, 2014, as follows.

Interest Expense 38,800

Premium on Bonds Payable 1,200

Interest Payable 40,000

Bonds Issued at Premium on Interest Date

E14-4 (SL-Premium)

Celine Dion Company issued $876,000 of 9%, 20year bonds on January 1, 2014, at 101. Interest is payable semiannually on July 1 and January 1. Dion Company uses the straight-line method of amortization for bond premium or discount.

Prepare the journal entries to record the following.

(1) The issuance of the bonds.

(2) The payment of interest and the related amortization on July 1, 2014.

How do we amortize Premium account?

Debit Premium 219

Credit Premium 219

Debit Premium 8,760

Credit Premium 8,760

(3) The accrual of interest and the related amortization on December 31, 2014.

When companies issue bonds on other than the interest payment dates,

Buyers will pay the seller the interest accrued from the last interest payment date to the date of issue.

On the next semiannual interest payment date, purchasers will receive the full six months’ interest payment.

Bonds Issued between Interest Dates

On March 1, 2014, Taft Corporation issues 10-year bonds, dated January 1, 2014, with a par value of $800,000. These bonds have an annual interest rate of 6 percent, payable semiannually on January 1 and July 1. Taft records the bond issuance at par plus accrued interest as follows.

Bonds Issued between Interest Dates

Cash 808,000

Bonds Payable 800,000

Interest Expense ($800,000 x .06 x 2/12) 8,000

 Interest for January and February

On July 1, 2014, four months after the date of purchase, Taft pays the purchaser six months’ interest and makes the following entry.

Interest Expense 24,000

Cash 24,000

2. On June 1, 2014, Garfunkel Company issued $92,400 of 10%, 10year bonds dated January 1 at par plus accrued interest. Interest is payable semiannually on July 1 and January 1.

Prepare journal entries to record the following.

(a) The issuance of the bonds (need to include 5 months interest expense).

What is the amount interest expense to be recognized when issuing bonds?

(a) 4,620

(b) 3,850

(c) 96,250

(d) 92,400

(b) The payment of interest on July 1 (recognize 6 months interest expense).

E14-3 (Issue at Par + Accrued Interest)

How do you calculate the amount of interest (in cash) that is actually paid to the bondholder each period?

How do you calculate the amount of interest that is actually recorded as interest expense by the issuer of the bonds?

Valuation of Bonds Payable

(Stated Rate x Face Value of the Bond)

(Market Rate x Carrying Value of the Bond)

Bonds Issued at a Discount

Evermaster Corporation issued $100,000 (face amount) of 8% (stated rate) term bonds on January 1, 2014, due on January 1, 2019, with interest payable each July 1 and January 1. Investors require an effective-interest rate of 10% (market rate).

Calculate the bond proceeds.

Journal entry on date of issue, Jan. 1, 2014.

Cash 92,278

Discount on Bonds Payable 7,722

Bonds Payable 100,000

Bonds Issued at a Discount(Effective-Interest Method)

Interest Expense 4,614

Discount on Bonds Payable 614

Cash 4,000

Journal entry to record first payment and amortization of the discount on July 1, 2014.

Bonds Issued at a Discount(Effective-Interest Method)

(b) (Market Rate x CA)

(a) (Stated Rate x Face Value)

(c) Difference between (a) & (b)

Last period Carry amount

PLUS (c)

Journal entry to record accrued interest and amortization of the discount on Dec. 31, 2014.

Interest Expense 4,645

Interest Payable 4,000

Discount on Bonds Payable 645

Bonds Issued at a Discount(Effective-Interest Method)

92,892*0.1/2

100,000*0.8/2

4,645-4,000

92,892+645

Bonds Issued at a Discount(Effective-Interest Method)

P14-1

The following amortization and interest schedule reflects the issuance of 10 year bonds by Capulet Corporation on January 1, 2008. The company’s year end is December 31.

12/31/

P14-1

(a) Indicate whether the bonds were issued at a premium or a discount.

(b) Indicate whether the amortization schedule is based on the straight-line method or the effective interest method.

(c) Determine the stated interest rate and the effective interest rate.

Stated rate: 19,110/191,100

Effective rate:

10%

12%

11%

No market rate

P14-1

(d) On the basis of the schedule above, prepare the journal entry to record the issuance of the bonds on January 1, 2008.

Cash

Discount on B/P

B/P

(e) On the basis of the schedule above, prepare the journal entry to reflect the bond transactions and accruals for 2008 (Assuming interest is paid January 1.)

Interest Expense

Discount on B/P

Interest Payable

(f) On the basis of the schedule above, prepare the journal entries to reflect the bond transactions and accruals for 2015.

You have two entries in 2015: January 1st and December 31st.

Evermaster Corporation issued $100,000 (face amount) of 8% (stated rate) term bonds on January 1, 2014, due on January 1, 2019, with interest payable each July 1 and January 1. Investors require an effective-interest rate of 6% (market rate).

Calculate the bond proceeds.

Bonds Issued at a Premium (Effective-Interest Method)

Journal entry on date of issue, Jan. 1, 2014.

Cash 108,530

Premium on Bonds Payable 8,530

Bonds Payable 100,000

Bonds Issued at a Premium (Effective-Interest Method)

Interest Expense 3,256

Premium on Bonds Payable 744

Cash 4,000

Journal entry to record first payment and amortization of the premium on July 1, 2014.

Bonds Issued at a Premium (Effective-Interest Method)

(b) (Market Rate x CA)

(a) (Stated Rate x Face Value)

(c) Difference between (a) & (b)

Last period Carry amount

MINUS (c)

Bonds Issued at a Premium (Effective-Interest Method)

E14-5 (Effective Method)

Celine Dion Company issued $840,000 of 10% (stated rate), 20 year bonds on January 1, 2014, at 102. Interest is payable semiannually on July 1 and January 1. Celine Dion Company uses the effective-interest method of amortization for bond premium or discount. Assume an effective yield of 9.7705% (market rate).

Prepare the journal entries to record the following.

(a) The issuance of the bonds.

(b) The payment of interest and related amortization on July 1, 2014.

(c) The accrual of interest and the related amortization on December 31, 2014.

Date Cash Paid Interest Expense Premium CA
1/1/2014 856,800
7/1/2014 42,000
12/31/2014 42,000
What happens if Evermaster prepares financial statements at the end of February 2014? In this case, the company prorates the premium by the appropriate number of months to arrive at the proper interest expense, as follows.

Accrued Interest

February 2014

Interest Expense (4,000*2/6) 1,085.33

Premium on Bonds Payable (744*2/6) 248.00

Interest Payable 1,333.33

E14-8 (c)

(c) Ron Kenoly Inc. issued $609,200 of 8%, 8 year bonds on June 30, 2014, for 543,175. This price provided a yield of 10% on the bonds. Interest is payable semiannually on December 31 and June 30.

If Kenoly uses the effective interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2014.

18,106

27,159

54,318

36,212

Date Cash Interest Expense Discount CA
6/30/2014 543,175
12/30/2014 24,368
E14-9 (SL versus Effective Method)

On June 30, 2014, Mischa Auer Company issued $4,016,000 face value of 11% (stated rate), 19 year bonds at $4,354,726 (carry amount), a yield of 10% (market rate). Auer uses the effective interest method to amortize bond premium or discount. The bonds pay semiannual interest on June 30 and December 31.

(a) Prepare the journal entries to record the following transactions.

Date Cash Interest Expense Premium CA
30-Jun-14 4,354,726
31-Dec-14 220,880
30-Jun-15 220,880
31-Dec-15 220,880
E14-9 (SL versus Effective Method)

(a) Prepare the journal entries to record the following transactions.

The issuance of the bonds on June 30, 2014.

The payment of interest and the amortization of the premium on December 31, 2014.

The payment of interest and the amortization of the premium on June 30, 2015.

The payment of interest and the amortization of the premium on December 31, 2015.

(b) What is the amount of premium on the B/P at December 31st, 2015?

328,815

3,406

217,414

332,281

E14-9 (SL versus Effective Method)

(c) Provide the answers to the following questions.

(1) What amount of interest expense is reported for 2015?

217,579

217,414

434,993

6,767

(Check your amortization table! You can find out the total interest expense in 2015.)

(2) Will the bond interest expense reported in 2015 be the same as, greater than, or less than the amount that would be reported if the straight line method of amortization were used?

Amortization under SL
Total Premium Carry Amount-Face Value
Premium per year under SL method Total Premium/19
Interest Expense for 2015 under SL Cash Paid in 2015-Premium per year
E14-9 (SL versus Effective Method)

(3) Determine the total cost of borrowing over the life of the bond?

(4) Will the total bond interest expense for the life of the bond be greater than, the same as, or less than the total interest expense if the straight-line method of amortization were used?

Interest Expense for 19 years
Add: Principle Due
Minus: Cash Received when issuing
Total cost of borrowing
Unamortized bond issue costs are treated as a deferred charge and amortized over the life of the debt.

Cost of Issuing Bonds

Microchip Corporation sold $20,000,000 of 10-year debenture bonds for $20,795,000 on January 1, 2014. Costs of issuing the bonds were $245,000.

Jan. 1, 2014

Cash 20,550,000

Unamortized Bond Issue Costs 245,000

Premium on Bonds Payable 795,000

Bonds Payable 20,000,000

Dec. 31, 2014

Bond Issue Expense 24,500

Unamortized Bond Issue Costs 24,500

E14-8 Part (a)

(a) CeCe Winans Corporation incurred the following costs in connection with the issuance of bonds: (1) printing and engraving costs, $12,920; (2) legal fees, $48,650, and (3) commissions paid to underwriter, $74,550.

What amount should be reported as Unamortized Bond Issue Costs, and where should this amount be reported on the balance sheet?

136,120

12,920

123,200

48,650

Hint: printing and engraving costs + legal fees + commissions paid to underwriter

On January 1, 2007, General Bell Corp. issued at 97 bonds with a par value of $800,000, due in 20 years. It incurred bond issue costs totaling $16,000. Eight years after the issue date, General Bell calls the entire issue at 101 and cancels it.

Extinguishment of Debt

Bonds Payable 800,000

Loss on Redemption of Bonds 32,000

Discount on Bonds Payable 14,400

Unamortized Bond Issue Costs 9,600

Cash 808,000

E14-12

On January 2, 2009, Banno Corporation issued $2,040,000 of 10% bonds at 96 due December 31, 2018. Legal and other costs of $26,700 were incurred in connection with the issue. Interest on the bonds is payable annually each December 31. The $26,700 issue costs are being deferred and amortized on a straight-line basis over the 10 year term of the bonds.

The discount on the bonds is also being amortized on a straight-line basis over the 10 years.

The bonds are callable at 102 (i.e., at 102% of face amount), and on January 2, 2014, Banno called $1,224,000 face amount of the bonds and redeemed them.

Prepare the journal entry to record the redemption.

Reacquisition price 1,248,480
Net C.A. of bonds redeemed:
Face Value 1,224,000
Unamortized Discount (5 years)
Unamortized Issue costs
( only for 1,244,000 face amount, not for entire bonds)
Loss on Redemption
E14-12

Long-Term Notes Payable

Accounting for notes and bonds is quite similar.

A note is valued at the present value of its future interest and principal cash flows.

Company amortizes any discount or premium over the life of the note.

Scandinavian Imports issues a $10,000, three-year note, at face value to Bigelow Corp. The stated rate and the effective rate were both 10 percent ( issued at Par). Scandinavian would record the issuance of the note as follows.

Notes Issued at Face Value

Cash 10,000

Notes Payable 10,000

Interest Expense 1,000

Cash 1,000

($10,000 x 10% = $1,000)

Scandinavian Imports would recognize the interest incurred each year as follows.

Zero-Interest-Bearing Notes

Issuing company records the difference between the face amount and the present value (cash received) as

a discount and

amortizes that amount to interest expense over the life of the note.

Turtle Cove Company issued the three-year, $10,000, zero-interest-bearing note to Jeremiah Company. The implicit rate that equated the total cash to be paid ($10,000 at maturity) to the present value of the future cash flows ($7,721.80 cash proceeds at date of issuance) was 9 percent.

Cash 7,721.80

Discount on Notes Payable 2,278.20

Notes Payable 10,000.00

Zero-Interest-Bearing Notes

Interest Expense 694.96

Discount on Notes Payable 694.96

Turtle Cove records interest expense at the end of the first year as follows.

BE 14-13

Samson Corporation issued a 5year, $83,300, zero-interest-bearing note to Brown Company on January 1, 2014, and received cash of $49,434. The implicit interest rate is 11%.

What is the discount on Notes Payable Samson recognize when issuance?

0

33,866

83,300

49,343

Prepare Samson’s journal entries for the December 31 recognition of interest.

RELEVANT FACTS - Similarities

As indicated in our earlier discussions, GAAP and IFRS have similar liability definitions, and liabilities are classified as current and non-current.

Much of the accounting for bonds and long-term notes is the same for GAAP and IFRS.

RELEVANT FACTS - Differences

Under GAAP, companies are permitted to use the straight-line method of amortization for bond discount or premium, provided that the amount recorded is not materially different than that resulting from effective-interest amortization. However, the effective-interest method is preferred and is generally used. Under IFRS, companies must use the effective-interest method.

Under IFRS, companies do not use premium or discount accounts but instead show the bond at its net amount.

IFRS 14-3

On January 1, 2014, JWS Corporation issued $600,000 of 7% bonds, due in 10 years. The bonds were issued for $559,224, and pay interest each July 1 and January 1.

Prepare the company’s journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry. Assume an effective interest rate of 8%.

Date Cash Interest Expense Discount CA
1/1/2014 559,224
7/1/2014 21,000
1/1/2015 21,000