Explore BrainMass
Share

Explore BrainMass

    Bond Interest and Effective interest Methods

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Titania Co. sells $400,000 of 12% bonds on June 1, 2010. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2014. The bonds yields 10%. On October 1, 2011, Titania buys back $120,000
    worth of the bonds for $126,000 (includes accrued interest). Give the entries through December 31, 2012.

    © BrainMass Inc. brainmass.com October 10, 2019, 1:41 am ad1c9bdddf
    https://brainmass.com/business/interest-rates/bond-interest-effective-interest-methods-344811

    Solution Preview

    Bond Valuation
    2. Titania Co. sells $400,000 of 12% bonds on June 1, 2010. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2014. The bonds yields 10%. On October 1, 2011, Titania buys back $120,000 worth of the bonds for $126,000 (includes accrued interest). Give the entries through December 31, 2012.

    Remarks: Solutions provided for both straight line method and effective interest rate method.

    Straight line method
    If the coupon rate on a coupon issue exceeds the prevailing market interest rate for comparable bonds, the bonds will sell at an amount above their face value. We can find how much Titania sells the bond by using the following formula.

    where B is the issued price/current price
    C is the coupon payment
    r is the current interest rate/bonds yield
    n is the period

    C = ($400,000 x 0.12)/2 = $24,000
    n = 4 years x 2 = 8
    r = 0.10/2 = 0.05

    B = $24,000 x [1 - 1 ] + 400,000
    (1 + 0.05)8 (1 + 0.05)8
    0.05

    B = $425,853

    June 1, 2010 Cash 425,853
    Bonds payable 400,000
    Premium on bonds payable 25,853

    Amount received at issuance 425,853
    Amount to be repaid at maturity 400,000
    Excess of cash received over cash paid (premium) ( 25,853)
    Cash interest payments ($48,000 x 4) 192,000
    Total ...

    Solution Summary

    This solution is comprised of a detailed explanation to prepare journal entries for bond interest.

    $2.19