Question

4.    On January 1, 2017, Park Rapids Lumber Company issued $80 million in 20-year, 10% bonds payable. Interest is payable semiannually on June 30th and December 31st. Bond discounts and premiums are amortized straight-line at each interest payment date.

a.    Record the journal entry when the bonds were issued on January 1, 2017, make the necessary the journal entry to record the payment of bond interest on June 30, 2017, under each of the following assumptions:

1.    The bonds were issued at 98. Round your answers to the nearest dollar.

2.    The bonds were issued at 101. Round your answers to the nearest dollar.

b.    Compute the net bond liability at December 31, 2017, under assumptions 1 and 2 above. Round to the nearest dollar.

c.     Under which of the above assumptions, 1 or 2 would the investor’s effective rate of interest be higher? Explain.

5.    Early in the year Bill Barnes and several friends organized a corporation called Barnes Communications, Inc. The corporation was authorized to issue 50,000 shares of $100 par value, 10% cumulative preferred stock and 400,000 shares of $2 par value common stock. The following transactions (among others) occurred during the year:

Jan. 6   Issued for cash 20,000 shares of common stock at $14 per share. The shares were issued to Barnes and 10 other investors.

Jan. 7   Issued an additional 500 shares of common stock to Barnes in exchange for his services in organizing the corporation. The stockholders agreed that these services were worth $7,000.

Jan. 12 Issued 2,500 shares of preferred stock for cash of $250,000.

June 4 Acquired land as a building site in exchange for 15,000 shares of common stock. In view of the appraised value of the land and the progress of the company, the directors agreed that the common stock was be valued for purposes of this transaction at $15 per share.

Nov. 15 The first annual dividend of $10 per share was declared on the preferred stock to be paid December 20.

Dec. 20 Paid the cash dividend declared on November 15.

Dec. 31 After the financial statements were prepared, the net income for the year   was $147,200.

a.    Prepare journal entries to record the above transactions.

b.    Prepare the stockholders’ equity section of the Barnes Communications, Inc. balance sheet at December 31, 2016.

Answer 1

4.

a1.

January 1 : Bond issue at discount

Cash (80,000,000*98%)            78,400,000

Discount on Bonds Payable      1,600,000

             Bonds Payable                              80,000,000

30 June : Payment of Bond interest

Bond Interest Expense                                          4,040,000

             Cash (80,000,000*6/12*10%)                                4,000,000

             Discount on Bonds Payable (1,600,000/20*2)      40,000   

a2.

January 1 : Bond issue at premium

Cash (80,000,000*101%)                          80,800,000

             Premium on Bonds Payable                      800,000

             Bonds Payable                                           80,000,000

30 June : Payment of Bond interest

Bond Interest Expense                                          3,980,000

Premium on Bonds Payable (800,000/20*2)         20,000   

             Cash (80,000,000*6/12*10%)                                4,000,000

(b) Net Bond lliability under 1 (Discount)

Long term Liabilities:

Bond Payable, 10% due in 20 years                     80,000,000

Less : Discount on Bonds Payable                         1,600,000                          $78,400,000

(b) Net Bond lliability under 2 (Premium)

Long term Liabilities:

Bond Payable, 10% due in 20 years                     80,000,000

Add : Premium on Bonds Payable                         800,000                          $80,800,000

2 (c)

Effective rate of interest = Interest for the year / Value of bond

If issued at discount = 8,000,000 / 78,400,000 = 10.20% (approx)

If issued at premium = 8,000,000 / 80,800,000 = 9.90% (approx)

So, if the bond is issued at discount, effective interest rate will be higher.