Question

Alexi Co. issued $2.50 million face amount of 8%, 10-year bonds on June 1, 2019. The bonds pay interest on an annual basis on May 31 each year.

Required:
a. Assume that the market interest rates were slightly higher than 9% when the bods were sold. Would the proceeds from the bond issue have been more than, less than, or equal to the face amount? Explain
b. Independent of your answer to part a, assume that the proceeds were $2,134,000. Use the horizontal model to show the effect of issuing the bonds. Indicate the financial statement effect. (Enter your answers in whole dollars, not in millions. Enter decreases with a minus sign to indicate a negative financial statement effect.)

Answer 1

The proceeds from the bond issue would be less than the face amount due to the market interest rates being higher than the coupon rate. The horizontal model shows an increase in Cash and Bonds Payable, with the creation of a Discount on Bonds Payable account showing the bonds were sold at a discount.

Step-by-step explanation:

When Alexi Co. issued $2.50 million face amount of 8%, 10-year bonds when the market interest rates were slightly higher than 9%, the proceeds from the bond issue would have been less than the face amount. This is because the bonds' coupon rate was lower than the prevailing market interest rates, making them less attractive to investors unless they were sold at a discount. Since investors could get a better interest rate elsewhere, they would only buy Alexi Co.’s bonds if they were cheaper, reflecting a lower initial investment relative to the fixed interest payments.

Now, regarding the effect of issuing bonds for a proceed of $2,134,000 using the horizontal model:

• Cash account increases (debit) by $2,134,000.
• Bonds Payable account increases (credit) by the face amount of $2,500,000.
• Discount on Bonds Payable (a contra-liability account) increases (debit) by the difference of $366,000 ($2,500,000 face amount - $2,134,000 proceeds).

These entries will affect the balance sheet as an increase in assets (cash) and an increase in long-term liabilities (bonds payable and the discount on bonds payable). The discount on Bonds Payable reduces the carrying value of the bonds to the actual proceeds received.