Quiz 2

PROBLEM NO. 7 – Audit of bonds payable

On January 1, 2014, Thunder Corporation issued 2,000 of its 5-year, P1,000 face value, 11% bonds
dated January 1 at an effective annual interest rate(yield) of 9%. Interest is payable each December
31. Thunder uses the effective interest method of amortization. On December 31, 2015, the 2,000
bonds were extinguished early through acquisition in the open market by Thunder for P 1,980,000
plus accrued interest.

Jan 1, 2014 - Issuance

Cash 2,155, 534
Bonds Payable 2,000,000
Bonds Premium 155,534

Dec 31, 2014 – Interest

Interest Expense 220,000
Cash 220,000

Premium on Bonds 26,002

Interest Expense 26,002

Dec 31, 2015 – Amortization of premium until retirement

Premium on Bonds 28,342
Interest Expense 28,342

Bonds Payable 2,000,000

Premium on Bonds 101, 190
Interest Expense 220,000
Cash 2,200,000
Gain on early retirement 121, 190
On July 1, 2014, thunder issued 5,000 of its 6-year, P1,000 face value, 10% convertible bonds at
par. Interest is payable every June 30 and December 31. On the date of issue, the prevailing market
interest rate for similar debt without the conversion option is 12%. On July 1, 2015, an investor in
Thunder’s convertible bonds tendered 1,500 bonds for conversion into 15,000 ordinary shares of
Thunder, which had a fair value of P105 and a par value of P1 at the date of conversion.

July 1, 2014 – Issuance

Cash 4,580,950
Discount on Bonds Payable 419,050
Bonds Payable 5,000,000

Dec 31, 2014 – Interest

Interest Expense 250,000
Cash 250,000

Dec 31, 2014 – Amortization ([4,580,950 x 6%] -250,000)

Interest Expense 24,857
Discount on BP 24,857

July 1, 2015 - Conversion

Bonds Payable 5,000,000
Discount on BP

REQUIRED:
Based on the above and the result of your audit, determine the following:
(Round off present value factors to four decimal places)
1. Issue price of the 2,000 5 year bonds
2. Carrying amount of the 2,000 5 year bonds at December 31, 2014
3. Gain on early retirement of bonds on December 31, 2015
4. Equity component of the 6-year bonds
5. Increase share premium as a result of the conversion of the 1,500 6-year

SOLUTION:

Requirement No. 1

PV of principal (P2,000,000 x 0.6499) 1,299,800

PV of interest [(P2,000,000 x .11) x 3.8897] 855,734

Issue price 2,155,534

Requirement No. 2

Carrying amount, 1/1/11 (see no. 1) 2,155,534

Less premium amortization for 2011:

Nominal interest (P2,000,000 x .11) 220,000

Effective interest (P2,155,534 x .09) 193,998 26,002

Carrying amount, 12/31/11 2,129,532

Alternative computation:

PV of principal (P2,000,000 x 0.7084) 1,416,800

PV of interest [(P2,000,000 x .11) x 3.2397] 712,734

Carrying amount, 12/31/11 2,129,534

Requirement No. 3

Retirement price 1,980,000

Carrying amount,
12/31/12:

Carrying amount, 12/31/11 (see no. 1) 2,129,532

Less premium amortization for 2012:

Nominal interest (P2,000,000 x .11) 220,000

Effective interest (P2,129,532 x .09) 191,658 28,342 2,101,190

Gain early retirement of bonds 121,190

Alternative computation:

PV of principal (P2,000,000 x 0.7722) 1,544,400

PV of interest [(P2,000,000 x .11) x 2.5313] 556,886

Carrying amount, 12/31/10 2,101,286

Retirement price 1,980,000

Gain early retirement of bonds 121,286

Requirement No. 4

Total proceeds 5,000,000

Less liability component:

Present value of the principal (P5,000,000 x 0.4970) 2,485,000

Present value of the interest [(P5,000,000 x .05 x
8.3838) 2,095,950 4,580,950

Equity component 419,050

Requirement No. 5

PV of principal (P1,500,000 x 0.5584) 837,600

PV of interest [(P1,500,000 x .05) x 7.3601] 552,008

Carrying amount, 7/1/12 1,389,608

Par value of shares issued (15,000 shares x P1) (15,000 )

Net increase in share premium 1,374,608