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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.

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

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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 ...

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