Question

On the first day of its fiscal year, Ebert Company issued $50,000,000 of 10-year, 7% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 9%, resulting in Ebert receiving cash of $43,495,895. The company uses the interest method.

a. Journalize the entries to record the following:

1. sale of the bonds.
2. First semiannual interest payment, including amortization of discount.
3. Second semiannual interest payment, including a of discount.

b. Compute the amount of the bond interest expense for the first year.
c. Explain why the company was able to issue the bonds for only $43,495, 895 rather than for the face amount of $50,000,000.

Answer 1

Ebert Company

Journal Entries:

1) Debit Cash $43,495,895

Debit Bonds Discounts $6,504,105

Credit Bonds Payable $50,000,000

To record the sale of the bonds at a discount.

2) First semiannual interest payment:

Debit Interest Expense $1,957,315

Credit Amortization $207,315

Credit Cash $1,750,000

To record the first semiannual interest payment.

3) Second semiannual interest payment:

Debit Interest Expense $1,966,644

Credit Amortization $216,644

Credit Cash $1,750,000

To record the second semiannual interest payment.

b. Bond interest for the first year = $3,923,959 ($1,957,315 + $1,966,644)

c. The company issued the bonds at a discount at a coupon rate of 7%, which is less than the market interest rate of the bonds (9%).

Step-by-step explanation:

a) Data and Calculations:

Face value of bonds = $50,000,000

Price received = $43,495,895

Discount = $6,504,105

Coupon interest rate = 7%

Interest payment = semiannually

Maturity period = 10 years

Market (effective) interest rate = 9%

1) Cash $43,495,895 Bonds Discounts $6,504,105 Bonds Payable $50,000,000

2) First semiannual interest payment:

Interest Expense $1,957,315 Amortization $207,315 Cash $1,750,000

Cash payment = $1,750,000 ($50,000,000 * 3.5%)

Interest expense = 1,957,315 ($43,495,895 * 4.5%)

Amortization = $207,315

Fair value of bonds = $43,703,210 ($43,495,895 + $207,315)

3) Second semiannual interest payment:

Interest Expense $1,966,644 Amortization $216,644 Cash $1,750,000

Cash payment = $1,750,000 ($50,000,000 * 3.5%)

Interest expense = 1,966,644 ($43,703,210 * 4.5%)

Amortization = $216,644