Question

Chang Corporation issued $4,000,000 of 9%, ten-year convertible bonds on July 1, 2014 at 96.1 plus accrued interest. The bonds were dated April 1, 2014 with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2015, $800,000 of these bonds were converted into 500 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.

1. If "interest payable" were credited when the bonds were issued, what should be the amount of the debit to "interest expense" on October 1, 2014?

2. What should be the amount of the unamortized bond discount on April 1, 2015 relating to the bonds converted?

3. What was the effective interest rate on the bonds when they were issued?

a) 9% b)

above 9% c)

below 9% d)

cannot determine from the information given.

Answer 1

1. $94,000

2. $28,800

3. b. above 9%

Step-by-step explanation:

1. If "interest payable" were credited when the bonds were issued, what should be the amount of the debit to "interest expense" on October 1, 2014?

Monthly amount to debit = [$4,000,000 - ($4,000,000 × 96.1%)] ÷ 117 = $156,000 ÷ 117 = $1,333.33 per month

Amount to debit (for 3 months covering July 1 to October 1) = [$4,000,000 × 0.09 × (3 ÷ 12)] + [$1,333.33 × 3] = $94,000.

2. What should be the amount of the unamortized bond discount on April 1, 2015 relating to the bonds converted?

Unamortized bond discount = {[$4,000,000 - ($4,000,000 × 96.1%)] - [($1,333.33 × 3) + ($1,333.33 × 6)]} × ($800000 ÷ $4000000) = $28,800

3. What was the effective interest rate on the bonds when they were issued?

EMR = (1 + (i/n))^n - 1 ................................... (1)

Where;

i = nominal interest rate = 9%, 0.09

n = number of compounding period per year = 120 months

Substitute the values into equation (1), we have:

EMR = (1 + (0.09/120))^120 - 1 = 0.0941, or 9.41%

Therefore, the Effective Monthly Rate (EMR) implied is 9.41% which is above 9%.