Corporation 5

Illustration 1: Assume that Acropolis Company on January 1, 2017, issues $100,000 of 9% bonds, due in
five years, with interest payable annually at year-end.

The purchaser of the bonds would receive the following two types of cash payments:
(1) principal of $100,000 to be paid at maturity, and

(2) five $9,000 interest payments ($100,000 x 9%) over the term of the bonds.

Required:- determine the issue price (selling price)

Solution

The current market price of a bond is equal to the present value of all the future cash payments promised
by the bond.

Present value of the principal 64,993

Principle x P.V. $1 (n= 5 i= 9%)
100,000 x 0.6499

+ Present value of the interest payments 35,007

interest x P.V. A (n= 5 i= 9%)
9,000 x 3.8897
Present value (selling price) of the bonds 100,000
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Bond contractual
interet rate
(10%)

1- The market rate 2- The market rate 3- The market rate

is is is
8% 10% 12%

Bonds sold at Bonds sold at Face Bonds sold at

Premium. value. Discount

Example:-

On January 1, 2012, Masterwear Industries issued $700,000 of 12% bonds. Interest $42,000 is
payable semiannually on January 1 and July 1.

The bonds mature in three years (an unrealistically short maturity to shorten the illustration).

The entire bond issue was sold in a private placement to United Intergroup at the principal
amount
Solution
Masterwear (Issuer) United (Investor)

At Cash 700,000 Investment in bonds 700,000

issuance Bond payable 700,000 Cash 700,000

(Jan. 1)

July 1, Bond interest expense 42,000 Cash 42,000

Cash 42,000 interest revenue 42,000

Dec. 31, interest expense 42,000 interest receivable 42,000

interest payable 42,000 interest revenue 42,000

,
 Corporation 9

Bonds issued between interest dates:

assume Masterwear was unable to sell the bonds in the previous example until March I-two months after
they are dated. This variation is shown in Illustration United would pay the price of the bonds $700,000
plus $14,000 accrued interest

12 2
Interest for March 1 = 700,000 x 𝑥 = 14,000
12 12

Masterwear (Issuer) United (Investor)

Cash 714,000 Investment in bonds 700,000
Bonds payable 700,000 Interest receivable 14000
interest payable 14,000 Cash 714,000

At the first interest date

interest expense 28,000 Cash 42,000

Interest payable 14,000 interest revenue 28,000
Cash 42,000 Interest receivable 14,000

Bonds Issued at a Discount

Example:-

Evermaster Corporation issued $100,000 of 8 percent term bonds on January 1, 2020, due on
January 1, 2025, with interest payable each July 1 and January 1.

the investors required an effective-interest rate of 10 percent

solution
Maturity value of bonds payable 100,000
Present value of principle 61,391
Principle x P.V. $1 (n=10 i=5%)
100,000 X 0.61391

Present value of interest payable 30,887

Interest x P.V.O.A (n=10 i=5%)
(100000 x 8% x 6/12) = 4000 X 7.72173

proceeds from sale of bonds 92,278

= Discount on bonds payable 7,722
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Schedule of Bond Discount Amortization

Effective Interest Method- Semiannual Interest Payments
5 year, 8% bonds to yield 10%
Date Cash Interest Discount Carrying
Paid Expense Amortized amount
of Bonds
1/1/20 92,278
7/1/20 4000a 4614b 614c 92,892d
1/1/21 4000 4645 645 93,537
7/1/21 4000 4677 677 94,214
1/1/22 4000 4711 711 94,925
7/1/22 4000 4746 746 95,671
1/1/23 4000 4783 783 96,454
7/1/23 4000 4823 823 97,277
1/1/24 4000 4864 864 98,141
7/1/24 4000 4907 907 99,048
1/1/25 4000 4952 952 100,000

Masterwear (Issuer) United (Investor)

(Jan. 1) Cash 92278 Investment in bonds 100,000

Discount on bonds pay. 7722 Discount in bond invest 7722

Bond payable 100,000 Cash 92278

July 1, interest expense 4614 Cash 4000

discount on bond 614 Discount on bond invest 614

Cash 4000 interest revenue 4614

July 1, interest expense 4645 Interest receivable 4000

discount on bond 614 Discount on bond invest 645

interest payable 645 interest revenue 4645