McGee Company issued $400,000 of 8%, 20-year bonds on January 1, 2014. Interest is payable...
Question:
McGee Company issued $400,000 of 8%, 20-year bonds on January 1, 2014. Interest is payable semiannually on July 1 and January 1. McGee Company uses the effective interest method of amortization for bond premium or discount.
Assume an effective yield of 6% in pricing the bond.
Instructions:
Calculate the price of the bond
Prepare the first 4 periods of amortization schedule
Prepare the journal entries to record the following. (Round to the nearest dollar)
(a) The issuance of the bonds
(b) The payment of interest and the related amortization on July 1, 2014
(c) The accrual of interest and the related amortization on December 31, 2014.
Bonds:
Bonds are financial instruments issued by companies in order to raise capital. Each bond has a stated face value which is the amount to be repaid upon maturity as well as a stated interest rate which dictates the interest to be paid to investors periodically over the life of the bond. The issuance price of a bond is determined by the bond's interest rate in comparison to the market rate of interest.
Answer and Explanation:
Calculate the price of the bond
The price of the bond will equal the present value of the principal plus the present value of the interest payments.
PV of Principal
- PV of Principal = Principal x PV Factor
Searching the table below under row 40 (20 years x 2 periods per year), column 3% (6% market per year / 2 periods per year), we find that the PV factor equals 0.3066
Periods | 1% | 2% | 3% | 4% | 5% | 6% | 7% | 8% | 9% | 10% |
---|---|---|---|---|---|---|---|---|---|---|
1 | 0.9901 | 0.9804 | 0.9709 | 0.9615 | 0.9524 | 0.9434 | 0.9346 | 0.9259 | 0.9174 | 0.9091 |
2 | 0.9803 | 0.9612 | 0.9426 | 0.9246 | 0.907 | 0.89 | 0.8734 | 0.8573 | 0.8417 | 0.8264 |
3 | 0.9706 | 0.9423 | 0.9151 | 0.889 | 0.8638 | 0.8396 | 0.8163 | 0.7938 | 0.7722 | 0.7513 |
4 | 0.961 | 0.9238 | 0.8885 | 0.8548 | 0.8227 | 0.7921 | 0.7629 | 0.735 | 0.7084 | 0.683 |
5 | 0.9515 | 0.9057 | 0.8626 | 0.8219 | 0.7835 | 0.7473 | 0.713 | 0.6806 | 0.6499 | 0.6209 |
6 | 0.942 | 0.888 | 0.8375 | 0.7903 | 0.7462 | 0.705 | 0.6663 | 0.6302 | 0.5963 | 0.5645 |
7 | 0.9327 | 0.8706 | 0.8131 | 0.7599 | 0.7107 | 0.6651 | 0.6227 | 0.5835 | 0.547 | 0.5132 |
8 | 0.9235 | 0.8535 | 0.7894 | 0.7307 | 0.6768 | 0.6274 | 0.582 | 0.5403 | 0.5019 | 0.4665 |
9 | 0.9143 | 0.8368 | 0.7664 | 0.7026 | 0.6446 | 0.5919 | 0.5439 | 0.5002 | 0.4604 | 0.4241 |
10 | 0.9053 | 0.8203 | 0.7441 | 0.6756 | 0.6139 | 0.5584 | 0.5083 | 0.4632 | 0.4224 | 0.3855 |
11 | 0.8963 | 0.8043 | 0.7224 | 0.6496 | 0.5847 | 0.5268 | 0.4751 | 0.4289 | 0.3875 | 0.3505 |
12 | 0.8874 | 0.7885 | 0.7014 | 0.6246 | 0.5568 | 0.497 | 0.444 | 0.3971 | 0.3555 | 0.3186 |
13 | 0.8787 | 0.773 | 0.681 | 0.6006 | 0.5303 | 0.4688 | 0.415 | 0.3677 | 0.3262 | 0.2897 |
14 | 0.87 | 0.7579 | 0.6611 | 0.5775 | 0.5051 | 0.4423 | 0.3878 | 0.3405 | 0.2992 | 0.2633 |
15 | 0.8613 | 0.743 | 0.6419 | 0.5553 | 0.481 | 0.4173 | 0.3624 | 0.3152 | 0.2745 | 0.2394 |
16 | 0.8528 | 0.7284 | 0.6232 | 0.5339 | 0.4581 | 0.3936 | 0.3387 | 0.2919 | 0.2519 | 0.2176 |
17 | 0.8444 | 0.7142 | 0.605 | 0.5134 | 0.4363 | 0.3714 | 0.3166 | 0.2703 | 0.2311 | 0.1978 |
18 | 0.836 | 0.7002 | 0.5874 | 0.4936 | 0.4155 | 0.3503 | 0.2959 | 0.2502 | 0.212 | 0.1799 |
19 | 0.8277 | 0.6864 | 0.5703 | 0.4746 | 0.3957 | 0.3305 | 0.2765 | 0.2317 | 0.1945 | 0.1635 |
20 | 0.8195 | 0.673 | 0.5537 | 0.4564 | 0.3769 | 0.3118 | 0.2584 | 0.2145 | 0.1784 | 0.1486 |
21 | 0.8114 | 0.6598 | 0.5375 | 0.4388 | 0.3589 | 0.2942 | 0.2415 | 0.1987 | 0.1637 | 0.1351 |
22 | 0.8034 | 0.6468 | 0.5219 | 0.422 | 0.3418 | 0.2775 | 0.2257 | 0.1839 | 0.1502 | 0.1228 |
23 | 0.7954 | 0.6342 | 0.5067 | 0.4057 | 0.3256 | 0.2618 | 0.2109 | 0.1703 | 0.1378 | 0.1117 |
24 | 0.7876 | 0.6217 | 0.4919 | 0.3901 | 0.3101 | 0.247 | 0.1971 | 0.1577 | 0.1264 | 0.1015 |
25 | 0.7798 | 0.6095 | 0.4776 | 0.3751 | 0.2953 | 0.233 | 0.1842 | 0.146 | 0.116 | 0.0923 |
26 | 0.772 | 0.5976 | 0.4637 | 0.3607 | 0.2812 | 0.2198 | 0.1722 | 0.1352 | 0.1064 | 0.0839 |
27 | 0.7644 | 0.5859 | 0.4502 | 0.3468 | 0.2678 | 0.2074 | 0.1609 | 0.1252 | 0.0976 | 0.0763 |
28 | 0.7568 | 0.5744 | 0.4371 | 0.3335 | 0.2551 | 0.1956 | 0.1504 | 0.1159 | 0.0895 | 0.0693 |
29 | 0.7493 | 0.5631 | 0.4243 | 0.3207 | 0.2429 | 0.1846 | 0.1406 | 0.1073 | 0.0822 | 0.063 |
30 | 0.7419 | 0.5521 | 0.412 | 0.3083 | 0.2314 | 0.1741 | 0.1314 | 0.0994 | 0.0754 | 0.0573 |
31 | 0.7346 | 0.5412 | 0.4 | 0.2965 | 0.2204 | 0.1643 | 0.1228 | 0.092 | 0.0691 | 0.0521 |
32 | 0.7273 | 0.5306 | 0.3883 | 0.2851 | 0.2099 | 0.155 | 0.1147 | 0.0852 | 0.0634 | 0.0474 |
33 | 0.7201 | 0.5202 | 0.377 | 0.2741 | 0.1999 | 0.1462 | 0.1072 | 0.0789 | 0.0582 | 0.0431 |
34 | 0.713 | 0.51 | 0.366 | 0.2636 | 0.1904 | 0.1379 | 0.1002 | 0.073 | 0.0534 | 0.0391 |
35 | 0.7059 | 0.5 | 0.3554 | 0.2534 | 0.1813 | 0.1301 | 0.0937 | 0.0676 | 0.049 | 0.0356 |
36 | 0.6989 | 0.4902 | 0.345 | 0.2437 | 0.1727 | 0.1227 | 0.0875 | 0.0626 | 0.0449 | 0.0323 |
37 | 0.692 | 0.4806 | 0.335 | 0.2343 | 0.1644 | 0.1158 | 0.0818 | 0.058 | 0.0412 | 0.0294 |
38 | 0.6852 | 0.4712 | 0.3252 | 0.2253 | 0.1566 | 0.1092 | 0.0765 | 0.0537 | 0.0378 | 0.0267 |
39 | 0.6784 | 0.4619 | 0.3158 | 0.2166 | 0.1491 | 0.1031 | 0.0715 | 0.0497 | 0.0347 | 0.0243 |
40 | 0.6717 | 0.4529 | 0.3066 | 0.2083 | 0.142 | 0.0972 | 0.0668 | 0.046 | 0.0318 | 0.0221 |
- PV of Principal = Principal x PV Factor
- PV of Principal = $400,000 x 0.3066
- PV of Principal = $122,640
PV of Interest
- PV of Interest = Semiannual Interest Payment x PV of Annuity Factor
Searching the table below under row 40 (20 years x 2 periods per year), column 3% (6% market per year / 2 periods per year), we find that the PV factor equals 23.1148. The semiannual interest payment totals $16,000 ($400,000 x 4%)
Periods | 1% | 2% | 3% | 4% | 5% | 6% | 7% | 8% | 9% | 10% |
---|---|---|---|---|---|---|---|---|---|---|
1 | 0.9901 | 0.9804 | 0.9709 | 0.9615 | 0.9524 | 0.9434 | 0.9346 | 0.9259 | 0.9174 | 0.9091 |
2 | 1.9704 | 1.9416 | 1.9135 | 1.8861 | 1.8594 | 1.8334 | 1.808 | 1.7833 | 1.7591 | 1.7355 |
3 | 2.941 | 2.8839 | 2.8286 | 2.7751 | 2.7232 | 2.673 | 2.6243 | 2.5771 | 2.5313 | 2.4869 |
4 | 3.902 | 3.8077 | 3.7171 | 3.6299 | 3.546 | 3.4651 | 3.3872 | 3.3121 | 3.2397 | 3.1699 |
5 | 4.8534 | 4.7135 | 4.5797 | 4.4518 | 4.3295 | 4.2124 | 4.1002 | 3.9927 | 3.8897 | 3.7908 |
6 | 5.7955 | 5.6014 | 5.4172 | 5.2421 | 5.0757 | 4.9173 | 4.7665 | 4.6229 | 4.4859 | 4.3553 |
7 | 6.7282 | 6.472 | 6.2303 | 6.0021 | 5.7864 | 5.5824 | 5.3893 | 5.2064 | 5.033 | 4.8684 |
8 | 7.6517 | 7.3255 | 7.0197 | 6.7327 | 6.4632 | 6.2098 | 5.9713 | 5.7466 | 5.5348 | 5.3349 |
9 | 8.566 | 8.1622 | 7.7861 | 7.4353 | 7.1078 | 6.8017 | 6.5152 | 6.2469 | 5.9952 | 5.759 |
10 | 9.4713 | 8.9826 | 8.5302 | 8.1109 | 7.7217 | 7.3601 | 7.0236 | 6.7101 | 6.4177 | 6.1446 |
11 | 10.3676 | 9.7868 | 9.2526 | 8.7605 | 8.3064 | 7.8869 | 7.4987 | 7.139 | 6.8052 | 6.4951 |
12 | 11.2551 | 10.5753 | 9.954 | 9.3851 | 8.8633 | 8.3838 | 7.9427 | 7.5361 | 7.1607 | 6.8137 |
13 | 12.1337 | 11.3484 | 10.635 | 9.9856 | 9.3936 | 8.8527 | 8.3577 | 7.9038 | 7.4869 | 7.1034 |
14 | 13.0037 | 12.1062 | 11.2961 | 10.5631 | 9.8986 | 9.295 | 8.7455 | 8.2442 | 7.7862 | 7.3667 |
15 | 13.8651 | 12.8493 | 11.9379 | 11.1184 | 10.3797 | 9.7122 | 9.1079 | 8.5595 | 8.0607 | 7.6061 |
16 | 14.7179 | 13.5777 | 12.5611 | 11.6523 | 10.8378 | 10.1059 | 9.4466 | 8.8514 | 8.3126 | 7.8237 |
17 | 15.5623 | 14.2919 | 13.1661 | 12.1657 | 11.2741 | 10.4773 | 9.7632 | 9.1216 | 8.5436 | 8.0216 |
18 | 16.3983 | 14.992 | 13.7535 | 12.6593 | 11.6896 | 10.8276 | 10.0591 | 9.3719 | 8.7556 | 8.2014 |
19 | 17.226 | 15.6785 | 14.3238 | 13.1339 | 12.0853 | 11.1581 | 10.3356 | 9.6036 | 8.9501 | 8.3649 |
20 | 18.0456 | 16.3514 | 14.8775 | 13.5903 | 12.4622 | 11.4699 | 10.594 | 9.8181 | 9.1285 | 8.5136 |
21 | 18.857 | 17.0112 | 15.415 | 14.0292 | 12.8212 | 11.7641 | 10.8355 | 10.0168 | 9.2922 | 8.6487 |
22 | 19.6604 | 17.658 | 15.9369 | 14.4511 | 13.163 | 12.0416 | 11.0612 | 10.2007 | 9.4424 | 8.7715 |
23 | 20.4558 | 18.2922 | 16.4436 | 14.8568 | 13.4886 | 12.3034 | 11.2722 | 10.3711 | 9.5802 | 8.8832 |
24 | 21.2434 | 18.9139 | 16.9355 | 15.247 | 13.7986 | 12.5504 | 11.4693 | 10.5288 | 9.7066 | 8.9847 |
25 | 22.0232 | 19.5235 | 17.4131 | 15.6221 | 14.0939 | 12.7834 | 11.6536 | 10.6748 | 9.8226 | 9.077 |
26 | 22.7952 | 20.121 | 17.8768 | 15.9828 | 14.3752 | 13.0032 | 11.8258 | 10.81 | 9.929 | 9.1609 |
27 | 23.5596 | 20.7069 | 18.327 | 16.3296 | 14.643 | 13.2105 | 11.9867 | 10.9352 | 10.0266 | 9.2372 |
28 | 24.3164 | 21.2813 | 18.7641 | 16.6631 | 14.8981 | 13.4062 | 12.1371 | 11.0511 | 10.1161 | 9.3066 |
29 | 25.0658 | 21.8444 | 19.1885 | 16.9837 | 15.1411 | 13.5907 | 12.2777 | 11.1584 | 10.1983 | 9.3696 |
30 | 25.8077 | 22.3965 | 19.6004 | 17.292 | 15.3725 | 13.7648 | 12.409 | 11.2578 | 10.2737 | 9.4269 |
31 | 26.5423 | 22.9377 | 20.0004 | 17.5885 | 15.5928 | 13.9291 | 12.5318 | 11.3498 | 10.3428 | 9.479 |
32 | 27.2696 | 23.4683 | 20.3888 | 17.8736 | 15.8027 | 14.084 | 12.6466 | 11.435 | 10.4062 | 9.5264 |
33 | 27.9897 | 23.9886 | 20.7658 | 18.1476 | 16.0025 | 14.2302 | 12.7538 | 11.5139 | 10.4644 | 9.5694 |
34 | 28.7027 | 24.4986 | 21.1318 | 18.4112 | 16.1929 | 14.3681 | 12.854 | 11.5869 | 10.5178 | 9.6086 |
35 | 29.4086 | 24.9986 | 21.4872 | 18.6646 | 16.3742 | 14.4982 | 12.9477 | 11.6546 | 10.5668 | 9.6442 |
36 | 30.1075 | 25.4888 | 21.8323 | 18.9083 | 16.5469 | 14.621 | 13.0352 | 11.7172 | 10.6118 | 9.6765 |
37 | 30.7995 | 25.9695 | 22.1672 | 19.1426 | 16.7113 | 14.7368 | 13.117 | 11.7752 | 10.653 | 9.7059 |
38 | 31.4847 | 26.4406 | 22.4925 | 19.3679 | 16.8679 | 14.846 | 13.1935 | 11.8289 | 10.6908 | 9.7327 |
39 | 32.163 | 26.9026 | 22.8082 | 19.5845 | 17.017 | 14.9491 | 13.2649 | 11.8786 | 10.7255 | 9.757 |
40 | 32.8347 | 27.3555 | 23.1148 | 19.7928 | 17.1591 | 15.0463 | 13.3317 | 11.9246 | 10.7574 | 9.7791 |
- PV of Interest = Semiannual Interest Payment x PV of Annuity Factor
- PV of Interest = $16,000 x 23.1148
- PV of Interest = $369,837 rounded
Issuance Price
- Issuance Price = PV of Principal + PV of Interest
- Issuance Price = $122,640 + $369,837
- Issuance Price = $492,477
Prepare the first 4 periods of amortization schedule
A | B | C | D | E | F | G |
---|---|---|---|---|---|---|
Date | Interest Payment Stated 4% x Face $400,000 |
Interest Expense Market 3% x Previous BV in G |
Amortization of Bond Premium (B - C) |
Bond Premium Account Balance Previous E - D |
Bonds Payable Account Balance | Book Value of Bonds (F + E) |
Jan. 1, 2014 | $92,477 | $400,000 | $492,477 | |||
July 1, 2014 | $16,000 | $14,774 | $1,226 | $91,251 | $400,000 | $491,251 |
Jan. 1, 2015 | $16,000 | $14,738 | $1,262 | $89,989 | $400,000 | 489,989 |
July 1, 2015 | $16,000 | $14,700 | $1,300 | $88,689 | $400,000 | $488,689 |
Jan. 1, 2016 | $16,000 | $14,661 | $1,339 | $87,350 | $400,000 | $487,350 |
Prepare the journal entries to record the following. (Round to the nearest dollar)
(a) The issuance of the bonds
Date | Account | Debit | Credit | Explanation |
---|---|---|---|---|
Jan. 1, 2014 | Cash | $492,477 | Record inflow of cash from issuance | |
Bonds Payable | $400,000 | Record bonds at face value | ||
Premium on Bonds Payable | $92,477 | Record amount received in excess of face value ($492,477 - $400,000) |
(b) The payment of interest and the related amortization on July 1, 2014
Date | Account | Debit | Credit | Explanation |
---|---|---|---|---|
July 1, 2014 | Interest Expense | $14,774 | Record interest expense for period (see amortization table) | |
Premium on Bonds Payable | $1,226 | Record amortization of premium ($16,000 - $14,774) | ||
Cash | $16,000 | Record outflow of cash made in payment of interest |
(c) The accrual of interest and the related amortization on December 31, 2014.
Date | Account | Debit | Credit | Explanation |
---|---|---|---|---|
December 31, 2014 | Interest Expense | $14,738 | Record interest expense for period (see amortization table) | |
Premium on Bonds Payable | $1,262 | Record amortization of premium ($16,000 - $14,738) | ||
Interest Payable | $16,000 | Record outflow of cash to be made in payment of interest on January 1 |
Learn more about this topic:
from Financial Accounting: Help and Review
Chapter 8 / Lesson 7