Question

Agee Technology, Inc., issued 9% bonds, dated January 1, with a face amount of $380 million on July 1, 2018, at a price of $370 million. For bonds of similar risk and maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31. Prepare the journal entry to record interest at the effective interest rate at December 31. What would be the amount(s) related to the bonds that Agee would report in its statement of cash flows for the year ended December 31, 2018, if it uses the direct method?

Answer 1

Part 1 Journal Entry

Journal Entry to record interest

Interest Expense A/c Dr. $17.1 million

To Interest Payable A/c $17.1 million

(Interest expense of Agee Technology on bonds of face value of $380 million @9% for 6 months.)

Interest Payable A/c Dr. $17.1 million

To Cash a/c $17.1 million

(Interest paid on the bonds for 6 months)

Part 2 Cash Flow

Amount related to bonds to be reported in cash flow statement

Issue of bonds = $370 million. (Financing Activity)

Less: Interest paid on 1 July = $380 million X 9% X 6/12 = $17.1 million

Less: Interest paid on 31 December = $380 million X 9% X 6/12 = $17.1 million

Net cash inflow from financing activities = $335.8

Step-by-step explanation:

1. Since bonds are dated 1 January though issued on 1 July interest for 6 months i.e. 1 January to 30 June will be paid.
2. Market rate of yield does not make any impact in calculations.
3. Interest will be calculated on face value of bonds, issue price does not matter.
4. The interest for the period from Jan to June will be paid on issue of bonds, i.e. on 1 July 2018 itself.
5. On 31 December interest will be paid only for 6 months.
6. In cash flow statement under direct method there is a change of pattern in reporting operating activities, there is no change in disclosing financing activities.