Prepare the journal entries to record the issuance of the bond and the interest payment on December 31, 2022.
On January 1, 2022, a company issued a 5-year, $100,000 bond at par value with a coupon rate of 6%. Interest is payable annually on December 31. The effective interest rate is 7%. Prepare the journal entries to record the issuance of the bond and the interest payment on December 31, 2022.
Answer:
The journal entry to record the payment of interest and amortization of discount on bonds payable on December 31, 2022, is as follows:
Debit the Interest expense account for the interest accrued on the bond, which is $7,000 ($100,000 x 7%).
Debit the Discount on bonds payable account for the amortization of the discount on the bond, which is $1,052 ($6,542 ÷ 5).
Credit the Cash account for the cash payment made for the interest, which is $5,948 ($7,000 - $1,052).
EXPLAINATION:
- Present value of the bond:
- The present value of the bond is calculated using the effective interest rate of 7% and the future cash flows from the bond. Since the bond has a face value of $100,000, a coupon rate of 6%, and is paid annually for five years, the cash flows are as follows:
- Year 1: $6,000
- Year 2: $6,000
- Year 3: $6,000
- Year 4: $6,000
- Year 5: $6,000 + $100,000
The present value of these cash flows is calculated using the formula for present value of an annuity and the present value of a lump sum. The calculation is as follows:
PV = ($6,000 ÷ 1.07) + ($6,000 ÷ 1.07^2) + ($6,000 ÷ 1.07^3) + ($6,000 ÷ 1.07^4) + (($6,000 + $100,000) ÷ 1.07^5)
PV = $5,610.73 + $5,237.67 + $4,887.31 + $4,558.06 + $89,879.56
PV = $110,172.33
Therefore, the present value of the bond is $110,172.33.
- Recording the issuance of the bond:
- On January 1, 2022, the company issued the bond at par value. The journal entry to record the issuance of the bond is:
Debit Cash for $100,000
Credit Bonds payable for $100,000
- Recording the payment of interest and amortization of discount on bonds payable:
- On December 31, 2022, the company paid the annual interest on the bond and amortized the discount on bonds payable. The interest expense is calculated as 7% of the carrying value of the bond, which is the face value of $100,000 plus the unamortized discount of $6,542, or $106,542. The interest expense is:
Interest expense = $106,542 x 7% = $7,449.94 ≈ $7,000
The amortization of the discount on bonds payable is calculated as the difference between the interest expense and the cash payment for the interest, or $449.94. This amount is divided by the remaining four years of the bond term to get the annual amortization of the discount:
Amortization of discount = $449.94 ÷ 4 = $112.49 ≈ $1,052
The journal entry to record the payment of interest and amortization of discount on bonds payable is:
Debit Interest expense for $7,000
Debit Discount on bonds payable for $1,052
Credit Cash for $5,948