Company Issued 14 5-Year Bonds With A Par Value Of 5,000,000

A company issued 14%, 5-year bonds with a par value of $5,000,000 on January 1, 2012. Interest is to be paid semiannually on June 30 and December 31. The bonds are issued at $5,368,035 when the market rate for similar bonds is 12%. Prepare the journal entries for:

1. Bond issuance on January 1, 2012, including reporting on the balance sheet;

2. The first semiannual interest payment on June 30, 2012, using the effective interest method;

3. The first semiannual interest payment on June 30, 2012, using the straight-line amortization method.

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A Company Issued 14 5 Year Bonds With a Par Value Of 5000000 On J

A company issued 14%, 5-year bonds with a par value of $5,000,000 on January 1, 2012. Interest is to be paid semiannually on June 30 and December 31. The bonds were issued at $5,368,035 when the market rate was 12%. The company uses the effective interest method for amortization but also considers straight-line amortization for comparison. This paper provides journal entries for bond issuance and the first interest payment under both amortization methods and discusses how these bonds are reported on the balance sheet.

Bond Issuance and Balance Sheet Reporting

On January 1, 2012, the company issued bonds with a face value of $5,000,000 at a premium. The bonds' issue price of $5,368,035 indicates a premium because the issue price exceeds the face value, reflecting the bond's coupon rate (14%) being higher than the prevailing market rate (12%). The premium amount is calculated as $5,368,035 - $5,000,000 = $368,035.

The journal entry at issuance, using the effective interest method, records the cash received, the bonds payable, and the premium on bonds payable:

Dr. Cash  $5,368,035


Cr. Bonds Payable  $5,000,000


Cr. Premium on Bonds Payable  $368,035

On the balance sheet, the bonds are reported at their carrying amount, which initially is the cash received, i.e., $5,368,035. The bonds payable is presented at its face value ($5,000,000), with the premium on bonds payable shown separately as a component of liabilities, adding to the total bond liability of $5,368,035.

First Semiannual Interest Payment – Effective Interest Method

The bonds pay interest semiannually at a coupon rate of 14%. The semiannual coupon payment is:

Interest Payment = Face Value × Coupon Rate / 2 = $5,000,000 × 14% / 2 = $350,000

Using the effective interest method, the interest expense for the period is based on the market rate at issuance (12%), applied to the carrying amount. The carrying amount at issuance is $5,368,035. The semiannual effective interest expense is:

Interest Expense = Carrying Amount × Market Rate / 2 = $5,368,035 × 12% / 2 ≈ $322,080.90

The amortization of the premium is the difference between the interest payment and the interest expense:

Amortization = $350,000 - $322,080.90 ≈ $27,919.10

The journal entry on June 30, 2012, is:

Dr. Interest Expense  $322,080.90


Dr. Premium on Bonds Payable  $27,919.10


Cr. Cash  $350,000

After this entry, the carrying amount of the bonds increases by the amortized amount, reflecting a decrease in the premium balance.

First Semiannual Interest Payment – Straight-line Method

Using straight-line amortization, the premium amortized each period is simply the total premium divided by the number of interest periods. The total premium of $368,035 is amortized over 10 periods (5 years × 2), so:

Amortization per period = $368,035 / 10 = $36,803.50

The interest expense is then the coupon payment minus amortization of the premium, resulting in a consistent interest expense each period. The journal entry on June 30, 2012, is:

Dr. Interest Expense  $350,000 - $36,803.50 = $313,196.50


Cr. Cash  $350,000

Alternatively, to record the amortization explicitly, the journal entry is:

Dr. Interest Expense  $313,196.50


Dr. Premium on Bonds Payable  $36,803.50


Cr. Cash  $350,000

Comparison and Reporting

The effective interest method results in a decreasing amortization of the premium over time, which reflects actual interest expense more accurately. The straight-line method simplifies accounting but may slightly overstate or understates interest expense in early periods. On the balance sheet, at January 1, 2012, bonds are reported net of the premium as a liability at $5,368,035, with the premium component adjusting the reported liability and increasing total liabilities.

Throughout the bond's life, the carrying amount will approach the face value as premiums are amortized, ensuring the liability is accurately reflected in financial statements. This presentation aids investors and creditors in assessing the company's debt obligations more precisely.

References

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