Reporting Bonds Issued At Par On January 1, 2014 ✓ Solved

Reporting Bonds Issued At Par Lo 10 2on January 1 2014 No

Describe the process of accounting for bonds issued at par value, including how to determine the issue price, record interest expenses, cash interest payments, and bond book values over the bonds' life, using the example of Nowell Company’s bonds issued January 1, 2014, with a face value of $500,000, an 8% stated rate, and maturity in five years. Explain the impact of market interest rates at issuance and illustrate the journal entries and calculations involved in recognizing interest expense and adjusting bond carrying amounts over time, considering the bonds’ interest payment schedule on June 30 and December 31 each year.

Sample Paper For Above instruction

The accounting for bonds issued at par value involves a straightforward process because the bonds are sold at their face value, reflecting a situation where the stated interest rate equals the market rate at the time of issuance. In the case of Nowell Company, bonds issued on January 1, 2014, with a face value of $500,000, a stated rate of 8%, and a maturity of five years, exemplify this scenario. This paper discusses the calculation of the issue price, the recording of interest expense, cash interest payments, and the bond's book value over time, providing an illustrative and detailed analysis.

Issue Price Calculation: When bonds are issued at par, the issue price equals the face value of the bonds because the coupon rate matches the prevailing market rate. To verify, the present value calculations involve discounting the future cash flows at the market rate of 8%. Since the bond's stated rate and market rate are equal, the present value of the bond's cash inflows (interest and principal) will exactly match its face value. The following formula confirms this:

PV of interest payments = PVA of $40,000 (8% of $500,000), paid semiannually, over 10 periods at 4% per period (since interest payments are semiannual).

PV of principal = $500,000 × PV factor for $1 at 5 years (10 periods at 4%).

By summing these present values, the issue price is determined, which, in this case, equals $500,000 due to the matching rates.

Interest Expense Recording: Each interest period, Nowell Company records interest expense, which, in the case of bonds issued at par, will equal the cash interest paid because the bonds are initially recorded at face value and the market rate equals the stated rate. On June 30 and December 31, 2014, the interest expense is computed as follows:

Interest expense = Carrying amount of bonds × market rate per period.

Since the bonds are issued at par, the carrying amount equals $500,000.

Interest expense = $500,000 × 8% annual rate / 2 = $20,000 per period.

Cash Interest Payments: The bonds pay interest twice a year to bondholders, calculated as:

Cash interest = Face value × stated interest rate ÷ 2 = $500,000 × 8% / 2 = $20,000.

Book Value of Bonds Over Time: Since bonds are issued at par, their initial book value is $500,000. Because interest expense equals the cash paid in interest, the bond's book value remains unchanged throughout the life of the bonds, until maturity. Therefore, on December 31, 2014, the book value remains at $500,000, and it stays at that amount until the bonds mature or are repaid.

Additional Considerations: If the bonds had been issued at a premium or discount, the carrying amount would fluctuate over time, resulting in interest expense adjustments reflecting amortization of the premium or discount. But in the case of bonds issued at par with matched market and stated rates, the accounting process simplifies considerably, providing clarity and ease in financial reporting.

In conclusion, issuing bonds at par involves recording the bonds at their face value with cash interest payments based on the stated rate. Over the bond’s term, the interest expense equals the cash interest paid due to the initial issuance at par when market and coupon rates match. This process ensures accurate reflection of the bond's financial position in the issuer's accounting records, facilitating clear financial analysis for stakeholders.

References

• Gelb, D. (2014). Financial accounting & reporting (11th ed.). McGraw-Hill Education.
• Horngren, C. T., Sundem, G. L., Elliott, J. A., & Philbrick, D. (2018). Introduction to Financial Accounting (11th ed.). Pearson.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2020). Intermediate Accounting (17th ed.). Wiley.
• Needles, B., & Powers, M. (2018). Financial Accounting, 12th Edition. Cengage Learning.
• Charles, A., & Business, A. (2019). Financial Statement Analysis. Routledge.
• Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2020). Financial Statement Analysis (12th ed.). McGraw-Hill Education.
• Brigham, E. F., & Ehrhardt, M. C. (2019). Financial Management: Theory & Practice (15th ed.). Cengage Learning.
• Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and Analysis. Wiley.
• Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.
• Birt, M., & Birt, C. (2014). Corporate Finance. Oxford University Press.