Question

Smiley Corporation wholesales repair products to equipment manufacturers. On April 1, Year 1, Smiley issued $1,400,000 of 5-year, 6% bonds at a market (effective) interest rate of 3%, receiving cash of $1,593,666. Interest is payable semiannually on April 1 and October 1.

Required:
a. Journalize the entries to record the following.

1. Issuance of bonds on April 1, Year 1.
2. First interest payment on October 1, Year 1, and amortization of bond premium for six months, using the straight-line method. (Round to the nearest dollar.)

b. Explain why the company was able to issue the bonds for $22,282,220 rather than for the face amount of $21,300,000.

Answer 1

a. Journalize the entries to record the following.

1. Issuance of bonds on April 1, Year 1.

Dr Cash 1,593,666

Cr Bonds payable 1,400,000

Cr Premium on bonds payable 193,666

2. First interest payment on October 1, Year 1, and amortization of bond premium for six months, using the straight-line method. (Round to the nearest dollar.)

premium per coupon = $193,666 / 10 coupons = $19,366.60

Dr Interest expense 22,633.40

Dr Premium on bonds payable 19,366.60

Cr Cash 42,000

b. Explain why the company was able to issue the bonds for $1,593,666 (not $22,282,220) rather than for the face amount of $1,400,000 (not $21,300,000).

Since the bond's coupon rate was higher than the market rate, investors were willing to pay more for the bond (premium) than its face value. At $1,593,666, the actual returns will equal the returns of a $1,400,000 bond issued at market rate.