Question

Activation Exercise 12-1: Bonds Issued at a Discount

Terms and Definitions

The interest rate paid on the face amount of a bond is called the of interest. The interest rate paid on similar risk bonds is called the of interest. When the contract rate of interest is less than the market rate of interest, the bonds will sell for their face value. The difference between the selling price and the face amount of the bonds in this case is called a .

Understanding the Business Transaction

On January 1, 2014 Jack Company issued the following bonds that have a ten-year maturity and pay interest semi-annually.

Face Value	Contract Rate	Market rate	The bonds will sell at:
$3,830,000	9%	12%

If the market rate of interest is greater than the contract rate of interest, the bonds will sell for than their face value because the bond will pay interest than a buyer could earn on similar risk bonds issued by another company.

Recording in the Accounting System

On January 1, 2014, Jack Company issues the $3,830,000, 9%, 10-year bonds described above for cash of $3,171,035. Journalize the issuance of the Jack Company bonds.

If an amount box does not require an entry, leave it blank.

When bonds sell at a discount, their carrying value will be their face value.

Financial Statement Impact

On July 1, 2014 Botwin Company issues $1,000,000, 10%, bonds payable due in 10 years. Click here and use the slider to select the relevant interest rate to answer the following questions.

1.a.	If the market rate of interest is 12%, what is the issue price of the bonds payable?
	$

b.	If the market rate of interest is 12%, what is the discount on the bonds payable?
	$

c.	If the market rate of interest is 12%, what is the carrying amount of the bonds payable on the date of issuance?
	$

d.	If the market rate of interest is higher than the contract rate of interest, the bonds will sell for their face value.

2.a.	If the market rate of interest is 14%, what is the selling price of the bonds payable?
	$

b.	If the market rate of interest is 14%, what is the discount on the bonds payable?
	$

c.	If the market rate of interest is 14%, what is the carrying amount of the bonds payable on the date of issuance?
	$

d.	If the contract rate of interest remains constant, the amount of the discount when the bond is issued will as the market rate of interest increases.

Answer 1

The interest rate paid on the face amount of a bond is called the contract rate of interest. The interest rate paid on similar risk bonds is called the market rate of interest. When the contract rate of interest is less than the market rate of interest, the bonds will sell for more than their face value. The difference between the selling price and the face amount of the bonds in this case is called a premium .

On January 1, 2014 Jack Company issued the following bonds that have a ten-year maturity and pay interest semi-annually.

Face Value	Contract Rate	Market rate	The bonds will sell at:
$3,830,000	9%	12%	a discount

if the market rate of interest is greater than the contract rate of interest, the bonds will sell for more than their face value because the bond will pay less interest than a buyer could earn on similar risk bonds issued by another company.