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On January 1, 2010, Drennen, Inc., Issued $3 Million Face Amount of 10-Year, 14%

. On January 1, 2010, Drennen, Inc., issued $3 million face amount of 10-year, 14% stated rate bonds when market interest rates were 12%. The bonds pay semiannual interest each June 30 and December 31 and mature on December 31, 2019.

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Pulkit Mahajan
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97 views3 pages

On January 1, 2010, Drennen, Inc., Issued $3 Million Face Amount of 10-Year, 14%

. On January 1, 2010, Drennen, Inc., issued $3 million face amount of 10-year, 14% stated rate bonds when market interest rates were 12%. The bonds pay semiannual interest each June 30 and December 31 and mature on December 31, 2019.

Uploaded by

Pulkit Mahajan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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. On January 1, 2010, Drennen, Inc.

, issued $3 million face amount of 10-year, 14%


stated rate bonds when market interest rates were 12%. The bonds pay
semiannual interest each June 30 and December 31 and mature on December 31,
2019.
Required:
a. Using the present value tables in Chapter 6, calculate the proceeds (issue
price) of Drennen, Inc.s, bonds on January 1, 2010, assuming that the bonds
were sold to provide a market rate of return to the investor.
The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14%

* $3,000,000

* 6/12

= $210,000

The term of the bond is 10 years,


N

= 10 *2
= 20

The semi-annual market interest rate


= 12% * 6/12
= 6%
The present value of Interest
= $210,000 for 20 periods at 6%
= $210,000 * 11.4699
= $2,408,679

Add the present value of the maturity amount of


= $3,000,000 in 20 periods at 6%
= $3,000,000 * 0.3118

= $935,400

The proceeds (issue price) of the bonds =


PV of interest + PV of maturity value =
$2,408,679

+ $935,400

= $3,344,079
b. Assume instead that the proceeds were $2,950,000. Use the horizontal model
(or write the journal entry) to record the payment of semiannual interest and the
related discount amortization on June 30, 2010, assuming that the discount of
$50,000 is amortized on a straight-line basis.
The semiannual discount amortization, straight-line basis
= $50,000 / 20 periods
= $2,500
Balance Sheet

Income Statement

.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses
In the balance sheet on the Assets we will show
Cash

(210,000)

In the Income statement we will show Expenses as


Interest Expense
Discount on Bonds Payable

(212,500)
2,500

Journal entry:

Particulars
Interest Expense

Debit
212,500

Credit

Cash
Discount on Bonds Payable

210,000
2,500

c. If the discount in part b were amortized using the compound interest


method, would interest expense for the year ended December 31, 2010, be more
than, less than, or equal to the interest expense reported using the straight-line
method of discount amortization? Explain.

Discount on bonds payable is amortized with a credit, and thus increases interest
expense. Under the straight-line basis, the amount of discount amortization is the same
each period.
Under the compound (or effective) interest method, the amount of discount
amortization increases each period. Thus, interest expense under the compound
method will be lower in the early years of the bonds life, and higher in the later years,
as compared to interest expense under the straight-line method of amortization.

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