Question

Diaz Company issued $180,000 face value bonds on January 1, 2018. The bonds had a 7% stated rate of interest and a five-year term. Interest paid in cash annually, beginning December 31, 2018. The bonds were at 98. The straight-line method is used for amortization.

a). Use a financial statements model like the one shown below to demonstrate how (1) January 1, 2018, bond issue and (2) December 31, 2018, recognition of interest expense, including the amortization of the discount, and the cash payment, affect the company's financial statements. Use + for the increase, - for decrease, and NA for not affected.

Assets = Liabilities + Equity | Rev. - Exp. = Net Inc. | Cash Flow

b). Determine the carrying value (face value less discount or plus premium) of the bond liability as of December 31, 2018

c). Determine the amount of interest expense reported on the 2018 income statement.

d). Determine the carrying value (face value less discount or plus premium) of the bond liability as of December 31, 2019

e). Determine the amount of interest expense reported on the 2019 income statement.

Answer 1

a) Horizontal model

	Assets	=	Liabilities	+	Equity	Rev	-	Exp	=	Net income	Cash flow
Jan 1,2018 bond issue	+176400		+176400								+176400 FA
Dec 31,2018 Interest expense	-12600		+720		-13320			+13320		-13320	-12600 OA

Bond issue = 180000*98% = 176400

Interest = (180000*7%)+(3600/5) = 13320

b) Carrying value on Dec 31,2018 = 176400+720 = 177120

c) Amount of interest expense = $13320

d) Carrying value on Dec 31,2019 = 177120+720 = 177840

f) Amount of interest expense = 13320