Accounting

What the Numbers Mean 9e

Demonstration Problem
Chapter 7 Problem 27
Bonds Payable Calculate Issue Price
and Amortize Discount

Problem Definition
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.

Problem Definition
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.

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.

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.

Problem Solution
a. The semi-annual interest payments on the bonds =

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate
14%

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount
14%

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount
14%

* $3,000,000

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14%

* $3,000,000

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14%

* $3,000,000 * 6/12 =

Problem Solution
a. The semi-annual interest payments on the bonds =
Stated Rate * Face amount * Period =
14%

* $3,000,000 * 6/12 =

$210,000
This amount represents the cash interest payment
that is due to the bondholder of record every six
months throughout the life of the bond. This is
true whether the bond is sold at a premium, at a
discount, or at par.

Problem Solution
a. The term of the bond is 10 years,

Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.

Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =

Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
12%

Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
12% * 6/12 =

Problem Solution
a. The term of the bond is 10 years,
or 20 semi-annual periods.
The semi-annual market interest rate =
12% * 6/12 = 6%
This is the interest rate used to discount the semiannual cash interest payments of $210,000 each
(i.e., the annuity) back to present value.

Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =

Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
$210,000
The semi-annual interest payment of $210,000 is

Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
$210,000 * 11.4699 =
The semi-annual interest payment of $210,000 is
multiplied by the present value of an annuity
factor (n=20, i=6%) from Table 6-5 in the text

Problem Solution
a. The present value of an annuity of
$210,000 for 20 periods at 6% =
$210,000 * 11.4699 = $2,408,679
The semi-annual interest payment is
multiplied by the present value of an annuity
factor (n=20, i=6%) from Table 6-5 in the text
to get the present value of the interest annuity.

Problem Solution
a. The present value of the maturity amount
of $3,000,000 in 20 periods at 6% =

Problem Solution
a. The present value of the maturity amount
of $3,000,000 in 20 periods at 6% =
$3,000,000
The par value of the bonds, which will be paid to the
bondholder of record on the maturity date, is

Problem Solution
a. The present value of the maturity amount
of $3,000,000 in 20 periods at 6% =
$3,000,000 * 0.3118 =
The par value of the bonds, which will be paid to the
bondholder of record on the maturity date, is
multiplied by the present value of $1 factor
(n=20, i=6%) from Table 6-4 in the text

Problem Solution
a. The present value of the maturity amount
of $3,000,000 in 20 periods at 6% =
$3,000,000 * 0.3118 = $935,400
The par value of the bonds, which will be paid to the
bondholder of record on the maturity date, is
multiplied by the present value of $1 factor
(n=20, i=6%) from Table 6-4 in the text
to get the present value of the maturity amount.

Problem Solution
a. The proceeds (issue price) of the bonds =

Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest

Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest
$2,408,679

Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest + PV of maturity value =
$2,408,679

Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest + PV of maturity value =
$2,408,679

+ $935,400 =

Problem Solution
a. The proceeds (issue price) of the bonds =
PV of interest + PV of maturity value =
$2,408,679
$3,344,079

+ $935,400 =

Problem Definition
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.

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.

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.

Problem Solution
b. The semiannual discount amortization,
straight-line basis =

Problem Solution
b. The semiannual discount amortization,
straight-line basis =
$50,000

Problem Solution
b. The semiannual discount amortization,
straight-line basis =
$50,000 / 20 periods =

Problem Solution
b. The semiannual discount amortization,
straight-line basis =
$50,000 / 20 periods =
$2,500

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
-210,000

The cash payment of $210,000 each six months

represents the par value of $3,000,000 times the
market rate of interest of 12% times the period of
time of 6/12.

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
Discount on
-210,000 Bonds Payable
+2,500

The amortization of bond discount increases the

carrying value of the bonds from
$3,000,000 - $50,000 = $2,950,000 to
$3,000,000 - $47,500 = $2,952,500.

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
Discount on
-210,000 Bonds Payable
+2,500

Interest
Expense
-212,500

When bond discount is amortized, interest expense is

the addition of the cash interest payment and the
discount amortized.

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
Discount on
-210,000 Bonds Payable
+2,500
Journal entry:
Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . .

Interest
Expense
-212,500

$212,500

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
Discount on
-210,000 Bonds Payable
+2,500

Interest
Expense
-212,500

Journal entry:
Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500
Cr. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$210,000

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
Discount on
-210,000 Bonds Payable
+2,500

Interest
Expense
-212,500

Journal entry:
Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500
Cr. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$210,000
Cr. Discount on Bonds Payable . . . . . . . . . . . . . .
2,500

Problem Solution
b.

Balance Sheet
Income Statement
.
Assets = Liabilities + Owners Equity Net income = Revenues - Expenses

Cash
Discount on
-210,000 Bonds Payable
+2,500

Interest
Expense
-212,500

Journal entry:
Dr. Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . $212,500
Cr. Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$210,000
Cr. Discount on Bonds Payable . . . . . . . . . . . . . .
2,500

The interest expense debit is the addition of the Cash

and Discount on Bonds Payable credits.

Problem Definition
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.

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.

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.

Problem Solution
c.

Discount on bonds payable is amortized with a

credit, and thus increases interest expense.

Problem Solution
c. 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.

Problem Solution
c.

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.

Problem Solution
c.

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.

Accounting
What the Numbers Mean 9e
You should now have a better understanding
of how to account for bonds payable.
Remember that there is a demonstration problem for
each chapter that is here for your learning benefit.

David H. Marshall
Wayne W. McManus
Daniel F. Viele