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 Long-term liabilities questions and answers

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

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