Question

Stuart Company issued bonds with a $154,000 face value on January 1, Year 1. The bonds had a 9 percent stated rate of interest and a five-year term. Interest is paid in cash annually, beginning December 31, Year 1. The bonds were issued at 102. The straight-line method is used for amortization.

Required
a. Use a financial statements model like the one shown next to demonstrate how (1) the January 1, Year 1, bond issue and (2) the December 31, Year 1, recognition of interest expense, including the amortization of the premium and the cash payment, affect the company's financial statements. Use + for increase or – for decrease. (In the Cash Flow column, use the initials OA to designate operating activity, IA for investing activity, and FA for financing activity. Columns for events that have no effect on any of the elements should be left blank.) (Note: Not all cells will require an input.)
b. Determine the carrying value (face value less discount or plus premium) of the bond liability as of December 31, Year 1.
c. Determine the amount of interest expense reported on the Year 1 income statement.
d. Determine the carrying value of the bond liability as of December 31, Year 2.
e. Determine the amount of interest expense reported on the Year 2 income statement.

Answer 1

a) Accounting equation

	Assets		=	Liabilities		+	Stockholder's equity		Statement of cash flow
Jan 1	Cash (154000*1.02)	157080		Bonds payable	154000				157080 FA
				Premium on bonds payable	3080
Dec 31	Cash (154000*9%)	-13860		Premium on bonds payable (3080/5)	-616		Interest expense	-13244	-13860 OA

b) Carrying value December 31, Year 1 = 154000+(3080-616) = 156464

c) Amount of interest expense = 13244

d) Carrying value of bonds liability Year 2 = 156464-616 = 155848

e) Interest expense = 13244