Question

Pat Inc, purchase the $100,000 face value outstanding bonds of Slinger Company, its 80% owned subsidiary, for $101,300 (to yield 7.5 annual interest) on January 1, 20X3. The bonds have a stated nominal interest rate of goodwill. The bonds were sold on January 1, 20X1, for $101,005 to yield 7,75% annual interest. The bonds mature on June 20X6. The bonds pay interest each January 1. Amortization of premiums are done using the effective interest amortization method. Instruction: 1. Prepare the 5-year amortization schedule for the bonds issued by Slinger. Date Payments 7.75% Internet Amortization Balance 1/1/X1 101,005 1/1X2 8,000 1/1X3 8,000 1/1X4 8,000 !/!/X5 8,000 1/1X6 8,000 2. Prepare the 3-year amortization schedule for the bonds purchased by Pat Inc. Date Payments 7.75% Internet Amortization Balance 1/1/X1 101,300 1/1/X2 8,000 1/1/X3 8,000 1/1/X4 8,000 3. Record the entries made by Slinger in 20X3 relative to the bonds. 4. Record the entries made by Pat Inc. in 20X3 relative to the bunds.

Answer 1

The amortization schedule is created using the effective interest method, which involves calculating interest expense based on the carrying amount and market rate, then amortizing the premium over the life of the bond. This process adjusts the carrying amount to match the bond's face value at maturity. Rising market rates lead to a lower bond price as the present value of future payments decreases to reflect higher required yields.

Step-by-step explanation:

When calculating the amortization schedule for bonds, the effective interest method is used to spread out the premium or discount over the bond's life until maturity. For a bond purchased at a premium (like Pat Inc.'s purchase), the premium decreases over time as it is amortized, reducing the carrying amount of the bond to its face value by the end of the term. This involves computing interest expense based on the carrying amount of the bond and the market interest rate (7.75% in the case of Slinger's bonds, 7.5% for Pat Inc.), then subtracting the actual cash interest paid based on the nominal rate to find the amount of the premium amortized each period.

To create an amortization schedule, for each period, you calculate the interest expense by multiplying the carrying amount by the market rate, then subtract the nominal interest (based on the bond's coupon rate) to determine the premium amortization. After each period, the amortization amount is subtracted from the carrying amount to calculate the new carrying amount for the next period. By the bond's maturity date, the carrying amount will have been reduced to the bond's face value through this process of amortization.

When market interest rates rise and a bond's yield to maturity increases, the present value of the bond's future interest payments and principal repayment diminishes, leading to a lower bond price. This reflects the need to provide a higher yield to a new investor to compensate for the higher prevailing interest rates in the economy or increased risk level.