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Bond accounting

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1. On June 1, 2005, Tocinto Company sold its 8-year, $1,000 face value, 9% bonds dated June 1, 2005 at an effective annual interest rate (yield) of 10%. Interest is payable semiannually, and the first interest payment date is September 1, 2005. Tocinto uses the effective interest method of amortization. Bond issue costs were incurred in preparing and selling the bond issue. The bonds can be called by Tacinto at 101 at any time on or after June 1, 2006.

Instructions:

a. Explain in your own words how the selling price would be determined.

b. Describe how all items related to the bomds would be presented in a balance sheet prepared immediately after the bond issue was sold.

c. Would the amount of bond discount amortization using the effective interest method of amortization be lower in the second or third year of the life of the bond issue? Why?

d. Assuming that the bonds were called in and retired on March 1, 2006, describe how should Tocinto report the retirement of the bonds on the 2006 income statement.

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The solution explains some questions relating to bond accounting

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a. Explain in your own words how the selling price would be determined.

The selling price would be the present value of interest and principal discounted at the effective rate. The semi annual interest is 1,000X9%X1/2 = $45, principal amount is $1,000, periods to maturity are 8X2=16(semi annual) and the discounting rate is 10%/2=5% (semi annual). Interest is an annuity and so the present value is calculated using the PVIFA table. For principal amount which is a lump sum we use the PVIF table
Price = 45 X PVIFA (16,5%) + 1,000 X PVIF (16,5%)
Price = 45X 10.8378+ 1,000 X 0.4581
Price = $945.81

b. Describe how all items related to the bomds would be presented in a balance sheet prepared immediately after the bond issue was sold. ...

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