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Worthington Company issued $1,000,000 face value, six-year, 10% bonds on July 1, 2010, when the...

Question:

Worthington Company issued $1,000,000 face value, six-year, 10% bonds on July 1, 2010, when the market rate of interest was 12%. Interest payments are due every July 1, and January 1. Worthington uses a calendar year-end.

1. Prepare the journal entry to record the issuance of the bonds on July 1, 2010.

2. Prepare the adjusting journal entry on December 31, 2010, to accrue interest expense.

3. Prepare the journal entry to record the interest payment on January 1, 2011.

4. Calculate the amount of cash that will be paid for the retirement of the bonds on the maturity date.

Bonds Payable

Bonds payable is a long-term debt issued by the company mainly for funding purposes. When issuing bonds, it is always coupled with interest payment as you are borrowing money from the bond investor.

Answer and Explanation:

1. Prepare the journal entry to record the issuance of the bonds on July 1, 2010.

If the market rate is higher than the nominal interest rate, the bonds issued at a discount.

We will compute for the price of the bonds using the present value of 1 formula:

{eq}PVIF~=~(1~/~1~+~r)^n\\ Whereas:\\ r~=~rate~per~interest~period\\ n~=~no.~of~interest~payments {/eq}

r = 6% (12% / 2 payments per year)

n = 12 payments (6 years x 2 payments per year

Accounts Debit Credit
Cash 496,969.40
Discount on Bonds Payable 503,030.60
Bonds Payable 1,000,000

2. Prepare the adjusting journal entry on December 31, 2010, to accrue interest expense.

In paying interest expense, the discount on bonds payable will be deducted from the total interest paid. Amortization of discount on bonds payable by using straight line amortization.

Accounts Debit Credit
Interest Expense 100,000
Discount on Bonds Payable (503,030.60 / 12 periods) 41,919.22
Accrued Interest Payable 58,080.78

3. Prepare the journal entry to record the interest payment on January 1, 2011.

Accounts Debit Credit
Accrued Interest Payable 58,080.78
Cash 58,080.78

4. Calculate the amount of cash that will be paid for the retirement of the bonds on the maturity date.

$1,041.919.22 is the cash payment for the retirement of the bonds, including interest payment.

Accounts Debit Credit
Bonds Payable 1,000,000
Interest Expense 100,000
Cash 1,041,919.22
Discount on Bonds Payable 58,080.78

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