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Bradford Company issued 12% bonds, dated January 1, with a face amount of $87 million on January...

Question:

Bradford Company issued 12% bonds, dated January 1, with a face amount of $87 million on January 1, 2018. The bonds mature on December 31, 2027 (10 years). For bonds of similar risk and maturity, the market yield is 14%, interest is paid semiannually on June 30 and December 31 appropriate

Required:

1. Determine the price of the bonds at January 1, 2018.

2. to 4. Prepare the journal entry to record their issuance by The Bradford Company on January 1, 2018, interest on June 30, 2018 and interest on December 31, 2018 (at the effective rate).

Bonds:

Bonds are long-term debt instruments issued by companies in exchange for capital. Bonds are issued at their face value, at a premium, or at a discount. A bond's issuance price depends on the bond's interest rate compared to the market rate. Any premium or discount on a bond must be amortized over the bond's life so that the bond's carrying value at the maturity date is equal to its face value.

Answer and Explanation:

Bond Price

To calculate the issuance price of a bond, we'll sum the present value of the bond principal and the present value of the interest payments.

Present Value of Principal

{eq}PV = \frac{FV}{(1+r)^n} {/eq}

where...

{eq}FV {/eq} = Future Value ($87,000,000),
{eq}r {/eq} = market rate of interest per period(14% per year / 2 periods per year = 7%),
{eq}n {/eq} = number of periods (10 years x 2 periods per year)

Inserting these figures, we'll solve.

{eq}PV = \frac{FV}{(1+r)^n} {/eq}

{eq}PV = \frac{\$87,000,000}{(1+0.07)^20} {/eq}

{eq}PV = \$22,482,453 {/eq}

Present Value of Interest Payments

{eq}PV_{ann} = P\left [ \frac{1-(1+r)^{-n}}{r} \right ] {/eq}

where...

{eq}P {/eq} = interest payment ($87,000,000 x 12% / 2 = $5,220,000),
{eq}r {/eq} = market rate of interest per period (7%),
{eq}n {/eq} = number of periods

Inserting the proper figures, we'll solve.

{eq}PV_{ann} = P\left [ \frac{1-(1+r)^{-n}}{r} \right ] {/eq}

{eq}PV_{ann} = \$5,220,000\left [ \frac{1-(1+0.07)^{-20}}{0.07} \right ] {/eq}

{eq}PV_{ann} = \$55,300,754 {/eq}

Issuance Price of Bond

  • Issuance Price = PV of Principal + PV of Interest Payments
  • Issuance Price = $22,482,453 + $55,300,754
  • Issuance Price = $77,783,207

Journal Entries

Date Account Debit Credit Explanation
Jan. 1 Cash $77,783,207 Record inflow of cash from issuance of bond
Discount on Bonds Payable $9,216,793 Record discount on issuance price ($87,000,000 - $77,783,207)
Bonds Payable $87,000,000 Record bonds payable at face value
June 30 Interest Expense $5,444,824 Record interest expense for 6 month period ($77,783,207 carrying value x 7% market rate)
Discount on Bonds Payable $224,824 Record amortization of discount ($5,444,824 - $5,220,000)
Cash $5,220,000 Record outflow of cash in payment of interest ($87 million x 6% stated rate)
Dec. 31 Interest Expense $5,460,562 Record interest expense for 6 month period (($77,783,207 + $224,824) x 7% market rate)
Discount on Bonds Payable $240,562 Record amortization of discount ($5,460,562 - $5,220,000)
Cash $5,220,000 Record outflow of cash in payment of interest ($87 million x 6%)

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