Question

On January 1, 2018, Teachers Credit Union issued 7%, 20-year bonds payable with face value of $500,000. The bonds pay interest on June 30 and December 31.

Fill in the blanks:

Requirement 1: If the market interest rate is 6% when TCU issues it’s bonds, will the bonds be priced at face value, at a premium or at a discount? Explain:

The 7% bonds issued when the market interest rate is 6% will be priced at (fill in blank with: discount, or premium or face value). They are ( fill in blank with: attractive or unattractive) in this market, so investors will pay (fill in blank with: face value, less than face value, or more than face value) to acquire them.

Requirement 2: If the market interest rate is 9% when Teacher Credit Union issues it’s bonds, will the bonds be priced at face value, at a premium or at a discount? Explain:

The 7% bonds issued when the market interest rate is 9% will be priced at (fill in blank with: discount, premium, face value). They are (fill in blank with: attractive or unattractive) in this market, so investors will pay ( fill in blank with: face value, more than face value, less than face value).


Requirement 3: The issue price of the bonds is 94. Journalize the bond transactions. (Assume bonds payable are amortized using the straight-line amortization method. Explain each Journal entry.

a.journalize the issuance of bonds on January 1, 2018

b. Journalize the payment of interest and amortization on June 30, 2018.

c. Journalize the payment of investment and amortization on December 31,2018

d. Retirement of the bond at maturity on December 31, 2037, assuming the last interest payment has already been recorded.

Answer 1

Answer:

1.- premium // attractive // more than face value

2.- discount // unattractive // less than face value

3.-

cash                470,000 debit

discount on BP 30,000 debit

       bonds payable    500,000 credit

--to record issueance of bonds--

interest expense    18,250 credit

  discount on BP                    750 credit

  Cash                                 17,500 credit

--to record payment of interest--

interest expense    18,250 credit

  discount on BP                    750 credit

  Cash                                 17,500 credit

--to record payment of interest--

bonds payable  500,000 debit

          cash                    500,000 credit

--to record payment of principal in bonds at maturity--

Explanation:

REQUIREMENT 1

Doing a simplification for didactic use

We could say the rate is determinate as follow:

coupon payment/price = rate

The coupon payment is determinate by the bond rate.

Investor will want a price that matches the market rate.  Thus, they will accept a higher price as the coupon payment if the bonds are issued at par value will yield above the market rate.

REQUIREMENT 2

Here is the opposite situation, they will want a lower price so when dividing the coupon payment over pprice a bettter rate is achieved.

REQUIREMENT 3

face value 500,000

issued at 94/100

issued 500,000 x 0.49 = 470,000

discount 500,000 - 470,000 = 30,000

amortization under sstraight line:

discount / number of payment

30,000 / (20 years x 2 payment) = 750

cash payment:

500,000 x 7% / 2 = 17,500

interest expense 17,500 + 750 = 18,250

under straight line method, all enries for the payment of interest are the same.

As we have done the last interest payment journal we just have to write-off the payable. the discount was write-off along with the itnerest payment.