Question

On January 1, 2019, Kelly Corporation acquired bonds with a face value of $500,000 for $483,841.79, a price that yields a 10% effective annual interest rate. The bonds carry a 9% stated rate of interest, pay interest semiannually on June 30 and December 31, are due December 31, 2022, and are being held to maturity. Required: Prepare journal entries to record the purchase of the bonds and the first two interest receipts using the: 1. straight-line method of amortization 2. effective interest method of amortization

Answer 1

striaght-line method:

interest expense 24.519,778 debit

cash 22,500.00 credit

discount on BP 2,019.78 credit

--first payment --

interest expense 24.519,778 debit

cash 22,500.00 credit

discount on BP 2,019.78 credit

--second payment--

Effective-rate

interest expense 24.192.09 debit

cash 22,500.00 credit

discount on BP 1,692.09 credit

--first payment --

interest expense 24.276.69 debit

cash 22,500.00 credit

discount on BP 1,776.69 credit

--second payment--

Step-by-step explanation:

First, We sovle for the amount of the discount

face value 500,000

proceeds 483,841.79

discount 16,158.21‬

under straight line we divide this for the total payments of the loan:

16,158.21 / 8 payments = 2.019,77625‬

This will be added to the cash outlay to get interst expense:

500,000 x 9% / 2 = 22,500

Now, under effective rate:

carrying value x market rate = interest expense

and the difference with the cash outlay is amortization

483,841.79 x 0.05 = 24,192.09

cash outlay (22,500)

amortization 1,692.09

Then second payment:

(483,841.79+1,692.09) = fair value = 485.533,88

485.533,88 x 0.05 = 24.276.69

cash outlay (22,500)

amortization 1,776.69