Question

Amortize Discount by Interest Method

On the first day of its fiscal year, Ebert Company issued $19,000,000 of 5-year, 8% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 10%, resulting in Ebert receiving cash of $17,532,812. The company uses the interest method.

a. Journalize the entries to record the following:

1. Sale of the bonds. Round amounts to the nearest dollar. If an amount box does not require an entry, leave it blank.

2. First semiannual interest payment, including amortization of discount. Round to the nearest dollar. If an amount box does not require an entry, leave it blank.

3. Second semiannual interest payment, including amortization of discount. Round to the nearest dollar. If an amount box does not require an entry, leave it blank.

b. Compute the amount of the bond interest expense for the first year. Round amounts to the nearest dollar.

Annual interest paid	$
Discount amortized
Interest expense for first year	$

c. Explain why the company was able to issue the bonds for only $17,532,812 rather than for the face amount of $19,000,000.

The bonds sell for less than their face amount because the market rate of interest is the contract rate of interest. Investors willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).

Answer 1

Ebert Company

1. Journal Entries:

Date	Account Titles and Explanation	Ref. no	Debit	Credit
1	Cash		$17,532,812
	Discount on bonds payable		$1,467,188
	Bonds Payable			$19,000,000
	(To record issue of bonds payable)
2	Interest Expense		$876,641
	Discount on bonds payable			$116,641
	Cash			$760,000
	(To record first semiannual interest payment and amortization of discount on bonds payable)
3	Interest Expense		$882,473
	Discount on bonds payable			$122,473
	Cash			$760,000
	(To record second semiannual interest payment and amortization of discount on bonds payable)

1. Bonds payable par value         $19,000,000

Cash received                                $17,532,812

Less: Discount on bonds               $1,467,188

1. First semiannual Interest expense = 17,532, 812 x 10% x 6/12 = $876,641

Interest payment = 19,000,000 x 8% x 6/12 = $760,000

Discount on bonds payable (discount amortization) = 876,641 – 760,000 = $116,641

1. Second semiannual interest expense -

Unamortized discount = 1,467,188 – 116,641 = $1,350,547

Carrying value of bonds payable = 19,000,000 – 1,350,547 = $17,649,453

Interest expense = carrying amount x market rate of interest

= 17,649,453 x 10% x 6/12 = 882,473

Interest payment = 19,000,000 x 8% x6/12 = 760,000

Discount on bonds payable (discount amortization) = 882,473 -760,000 = $122,473

1. Computation of the amount of bond interest expense for the first year:

Annual interest expense = 19,000,000 x 8% = $1,520,000

Add: Discount amortized = $116,641 + 122,473 = $239,114

Bond interest expense for first year = $1,759,114