Question

Several years ago Brant, Inc., sold $950,000 in bonds to the public. Annual cash interest of 8 percent ($76,000) was to be paid on this debt. The bonds were issued at a discount to yield 12 percent. At the beginning of 2016, Zack Corporation (a wholly owned subsidiary of Brant) purchased $190,000 of these bonds on the open market for $211,000, a price based on an effective interest rate of 6 percent The bond liability had a carrying amount on that date of $810,000. Assume Brant uses the equity method to account internally for its investment in Zack a. & b. What consolidation entry would be required for these bonds on December 31, 2016 and December 31, 2018? (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Round your intermediate answers to nearest whole number.)

Answer 1

The current market interest rate impacts the price paid for a bond; a ten-year bond at 6% would be worth less if purchased when the market rate is 9%. To calculate the purchase price, discount the bond's future cash flows at the new rate.

Step-by-step explanation:

When considering the purchase of an existing bond, the current market interest rate significantly influences the price you would be willing to pay. In the case of a local water company's issued $10,000 ten-year bond at an interest rate of 6%, if you are thinking about buying this bond one year before its maturity and the interest rates are now 9%, you would expect to pay less than the face value of the bond due to the higher prevailing interest rates, which make the bond's fixed interest payments less attractive.

To calculate what you would actually be willing to pay for the bond, you would discount the bond's future cash flows - in this case, the final interest payment of $600 and the principle of $10,000 - at the new interest rate of 9%. The present value of these cash flows can be calculated using the present value formula.