Question

On January 1, 2021, Pence Airlines issued $400,000 of its 20-year, 8% bonds. The bonds were priced to yield 10%. Interest is payable semiannually on June 30 and December 31. Pence Airlines records interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2021, the fair value of the bonds was $335,000 as determined by their fair value in the market. Show ALL calculations.

Required:
1. Determine the price of the bonds at January 1, 2021, and prepare the journal entry to record their issuance.
2. Prepare the journal entry to record interest on June 30, 2021 (the first interest payment).
3. Prepare the journal entry to record interest on December 31, 2021 (the second interest payment).
4. Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2021, balance sheet.

Answer 1

1) the price of the bonds can be determined by calculating the PV of the face value and coupon payments:

PV of face value = $1,000 / 1.05⁴⁰ = $142.05

PV of coupon payments = $40 x 17.159 (PV annuity factor, 5%, 40 periods) = $689.36

PV of each bond = $831.41 x 400 = $332,564

January 1, 2021, bonds issued at a discount

Dr Cash 332,564

Dr Discount on bonds payable 67,436

Cr Bonds payable 400,000

2) amortization of bond discount = (332,564 x 5%) - 16,000 = $628.20 ≈ $628

June 30, 2021, first coupon payment

Dr Interest expense 16,628

Cr Cash 16,000

Cr Discount on bonds payable 628

3) amortization of bond discount = (333,192 x 5%) - 16,000 = $659.60 ≈ $660

December 31, 2021, first coupon payment

Dr Interest expense 16,660

Cr Cash 16,000

Cr Discount on bonds payable 660

4) bonds carrying value on December 31, 2021 = $333,852 - $335,000 = $1,148

December 31, 2021, adjusting entry for bonds' fair market value

Dr Unrealized loss on bonds' fair value 1,148

Cr Fair value adjustment 1,148