Accounting Problem 1

 (CREDIT):

--written by thewirter197
--employed by Ashford University


 ---------------------------------------PROBLEM------------------------------------------------------------------

• What effect will this have on interest expense if the bonds are issued at a premium and a discount?
• If you issue $10,000,000, 30 year callable bonds at a 5% premium, with a call feature at 10 years, what effect will this have on interest expense the first ten years? Provide journal entries and a comparative table to explain the differences.
• If you issue $10,000,000, 30 year callable bonds at a 5% discount, with a call feature at 10 years, what effect will this have on interest expense the first ten years? Provide journal entries and a comparative table to explain the differences.

------------------------------------------ANSWER------------------------------------------------------------------

Part 1: The interest expense would be the same rate given to the bonds. This applies to interest expense bonds that are discount or premium. The bond will go down in value because of amortization. Amortization is the purpose cost of a intangible asset over a certain amount of time.

Part 2: Question 1: If you issue $10,000,000, 30 year callable bonds at a 5% premium, with a call feature at 10 years, what effect will this have on interest expense the first ten years? Provide journal entries and a comparative table to explain the differences.
Answer 1: The interest expense for the first ten years would be the same. The cash account would be cash debited for 10,500,000. The bonds payable account would be credited for 10,000,000. The premium on bonds payable account would be credited for 500,000. To calculate the premium, you would take 10,000,000 X 5% X 1/12. The equation would equal $41,666.67. Use calculator to do math.


(Journal Example):

Cash                                                    $10,500,000
            Bonds Payable                                                $10,000,000

Interest Expense                      $41,666.67
            Interest Payable                                   $41,666.67
            Premium on Bonds Payable                            $500,000

(After 10 Years):

Bonds Payable            $500,000
            Cash                                        $500,000

Part 3: Question 2: If you issue $10,000,000, 30 year callable bonds at a 5% discount, with a call feature at 10 years, what effect will this have on interest expense the first ten years? Provide journal entries and a comparative table to explain the differences.
Answer:  A bond with a discount would have a payment made with interest. The interest would be lower then the actual interest paid. The amortization would decrease the premium on the payable bond account. Each year, the amortization reduces the premium on the payable bond account. To put bluntly, every time interest is paid on the bond payable account the amount will be credited with a discount amount of 5%. Amortization will lower the premium vale more so less money will be spent year after year.

(Journal Entry):

part 1:
Cash          9,500,000
Discount on bonds payable 500,000
                              Bonds Payable                        10,000,000

part 2:
Interest Expense                    50,000
 Discount on bonds payable                 50,000



Reference:

http://www.ssctech.com/eBriefings/eBriefingArticle/tabid/597/Default.aspx?V=17&A=4534 (Links to an external site.)Links to an external site.
http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/amortization-2073