Question

Xonic Corporation issued $8.5 million of 20-year, 8 percent bonds on April 1, 2021, at 102. Interest is paid on March 31 and September 30 of each year, and all of the bonds in the issue mature on March 31, 2041 Xonic's fiscal year ends on December 31. Prepare the following journal entries.

a. April 1, 2021, to record the issuance of the bonds.

b. September 30, 2021, to pay interest and to amortize the bond premium.

c. March 31, 2041, to pay interest, amortize the bond premium, and retire the bonds at maturity (make two separate entries). Assume an adjusting entry was made on December 31, 2040, to recognize interest from October 1 to December 31.

d. What is the effect of amortizing the bond premium on (1) annual net income and (2) annual net cash flow from operating activities. (ignore possible income tax effects.)

Answer 1

Journal Entries for Xonic Corporation Bonds:

a. April 1, 2021 (Bond Issuance):

Debit: Cash (8,500,000 * 102%) = $8,670,000

Credit: Bonds Payable = $8,500,000

Credit: Bond Premium = $170,000 (8,500,000 * 2%)

b. September 30, 2021 (Interest and Premium Amortization):

Debit: Interest Expense (8,500,000 * 4% * 6/12) = $205,000

Credit: Cash = $205,000

Debit: Bond Premium (205,000 * 170,000 / 240,000) = $69,833.33

Credit: Cash = $69,833.33

Credit: Interest Payable (205,000 - 69,833.33) = $135,166.67

c. March 31, 2041 (Bond Maturity):

1. Interest Payment and Amortization:

Debit: Interest Expense (8,500,000 * 4% * 3/12) = $102,500

Debit: Bond Premium (102,500 * 170,000 / 360,000) = $34,166.67

Credit: Cash = $136,666.67

2. Bond Retirement:

Debit: Bonds Payable = $8,500,000

Credit: Cash = $8,500,000

d. Effect of Amortizing Bond Premium:

(1) Annual Net Income:

Amortization reduces net income by the amount amortized each year. In this case, the annual reduction is $69,833.33 (refer to entry b for September 30, 2021).

(2) Annual Net Cash Flow from Operating Activities:

Amortization is a non-cash expense, so it does not affect net cash flow from operating activities. Therefore, it has no impact on this metric.

Note: These entries assume a straight-line method for amortizing the bond premium. Other methods might require different calculations.