Question

On January 1, 2024, Power Ltd. issued bonds with a maturity value of $5 million for

$4,797,000, when the market rate of interest was 8%. The bonds have a contractual interest
rate of 7% and mature on January 1, 2029. Interest on the bonds is payable semi-annually
on July 1 and January 1 of each year. On January 1, 2024, Finance Company, a public
company, purchased Power Ltd. bonds with a maturity value of $1 million to earn interest.
On December 31, 2024, the bonds were trading at 98. Both companies' year end is
December 31.
Instructions
a. What amount did Finance Company pay for Power Ltd.'s bonds?
b. Prepare the journal entry for Finance Company (investor) on January 1, 2024.
c. Prepare a bond amortization schedule for Finance Company for the first four
interest periods.

Answer 1

a) Purchase price = Maturity value * Bond trading percentage

Purchase price = $1,000,000 * 98% = $980,000

So, Finance Company paid $980,000 for Power Ltd.'s bonds.

b)

Date: January 1, 2024

Account Debit: Investment in Power Ltd. Bonds $980,000

Account Credit: Cash $980,000

c) Interest Income = Face value * Contractual interest rate * (Days from last interest payment / Total days in the period)

Amortization of Premium = Interest Income - Cash Interest Received

Assumptions:

Total days in a semi-annual period (January 1 to July 1) = 182 days

Total days in a semi-annual period (July 1 to January 1) = 184 days (leap year 2024)

Interest Period 1 (January 1, 2024, to July 1, 2024):

Interest Income = $1,000,000 * 7% * (182/365) = $34,246.58

Amortization of Premium = $34,246.58 - ($1,000,000 * 7% / 2) = $34,246.58 - $35,000 = -$753.42 (since it's a premium)

Interest Period 2 (July 1, 2024, to January 1, 2025):

Interest Income = $1,000,000 * 7% * (184/366) = $34,520.55

Amortization of Premium = $34,520.55 - ($1,000,000 * 7% / 2) = $34,520.55 - $35,000 = -$479.45 (since it's a premium)

Interest Period 3 (January 1, 2025, to July 1, 2025):

Interest Income = $1,000,000 * 7% * (182/365) = $34,246.58

Amortization of Premium = $34,246.58 - ($1,000,000 * 7% / 2) = $34,246.58 - $35,000 = -$753.42 (since it's a premium)

Interest Period 4 (July 1, 2025, to January 1, 2026):

Interest Income = $1,000,000 * 7% * (184/366) = $34,520.55

Amortization of Premium = $34,520.55 - ($1,000,000 * 7% / 2) = $34,520.55 - $35,000 = -$479.45 (since it's a premium)

The pattern repeats for each subsequent interest period. Finance Company will continue to amortize the premium on the bonds until they mature on January 1, 2029.