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On February 1, Hansen Company purchased $126,000 of 5%, 15-year Knight Company bonds at their...

Question:

On February 1, Hansen Company purchased $126,000 of 5%, 15-year Knight Company bonds at their face amount plus one month's accrued interest. The bonds pay interest on January 1 and July 1.

On October 1, Hansen Company sold $45,600 of the Knight Company bonds acquired on February 1, plus three months' accrued interest.

On December 31, three months' interest was accrued for the remaining bonds.

Determine the interest earned by Hansen Company on Knight Company bonds for the year.

(Hint: Three interest components make up the interest earned in this exercise:

Feb.1 to July 1: Bond purchase amount x interest x {(6 months-1 months accrued at purchase) / 12 months}

July 1 to Oct. 1: Sold bond amount x interest x (3 months / 12 months)

July 1 to Dec. 31: (Original bond purchase less sold bonds) x interest x (6 months/12 months) )

Bonds Payable:

Bonds are long-term debt instruments issued by businesses to fund projects and operations. Bonds are characterized by their principal values and interest rates. The principal value is repaid upon maturity while interest rates determine the return earned on the bonds as well as the bonds' issuance price.

Answer and Explanation:

To know the interest earned during the year, let's take a look at the three journal entries which would be made:

Date Account Debit Credit Explanation
Feb. 1 Investment in Bonds $126,000 Record bonds at face value
Interest Receivable $525 Record interest receivable for one month ($126,000 x 5% / 12 months)
Cash $126,525 Record cash paid to purchase bond and interest
July 1 Cash $3,150 Record cash received for interest ($2,625 + $525)
Interest Receivable $525 Remove interest receivable established on Feb. 1
Interest Revenue $2,625 Record revenue earned for 5 months ($126,000 x 5% x (5 / 12))
Oct. 1 Cash $46,170 Record inflow of cash from sale ($45,600 + $570)
Interest Revenue $570 Record interest revenue for three months ($45,600 x 5% x (3 / 12))
Investment in Bonds $45,600 Remove investment at face value
Dec. 31 Interest Receivable $2,010 Record interest receivable for six months on remaining investment
Interest Revenue $2,010 Record interest revenue for six months (($126,000 - $45,600) x 5% x (6 / 12))

Adding up all of the interest revenue entries, we find that the interest earned by Hansen Company equals $5,205 ($2,625 + $570 + $2,010)


Learn more about this topic:

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Long-Term Debt: Definition, Cost & Formula

from Financial Accounting: Help and Review

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