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# Bond Interest and Effective interest Methods

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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.

#### 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

Amount to be repaid at maturity 400,000
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.

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Similar Posting

## Prepare entries to record issuance of bonds, payment of interest, and amortization of premium using effective-interest method

On July 1, 2006, S. Strigel Chemical Company issued \$5,000,000 face value, 10%, 10-year bonds at \$5,679,533. This price resulted in an 8% effective-interest rate on the bonds. Strigel uses the effective-interest method to amortize bond premium or discount.The bonds paysemiannual interest on each July 1 and January 1.

Instructions

(Round all computations to the nearest dollar.)

(a) Prepare the journal entries to record the following transactions.
(1) The issuance of the bonds on July 1, 2006.
(2) The accrual of interest and the amortization of the premium on December 31, 2006.
(3) The payment of interest and the amortization of the premium on July 1, 2007, assuming no accrual of interest on June 30.
(4) The accrual of interest and the amortization of the premium on December 31, 2007.

(b) Show the proper balance sheet presentation for the liability for bonds payable on the December 31, 2007, balance sheet.

(c) Provide the answers to the following questions in letter form.
(1) What amount of interest expense is reported for 2007?
(2) Would the bond interest expense reported in 2007 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used?
(3) Determine the total cost of borrowing over the life of the bond.
(4) Would the total bond interest expense be greater than, the same as, or less than the total interest expense if the straight-line method of amortization were used?

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