Universal Corporation issued $2 million of 5%, 10-year bonds on January 1, 2021. The bonds were dated January 1 and pay interest annually. There is no collateral secured against the bonds and Universal may buy back the bonds at any time. The market interest rate was 4% for these bonds. Universal has a calendar year end.

Instructions

a. Describe the features of these bonds.

b. Calculate the price of the bonds and record the bond issue.

c. Prepare an effective-interest amortization table for these bonds for the first five years. Round amounts to the nearest dollar.

d. Record any required adjusting entries and subsequent payment for the first three interest payments assuming reversing entries have not been used.

Taking It Further

Geoff doesn’t understand why the interest expense recorded is higher than the cash paid for interest when bonds are issued at a discount and why the interest expense is lower than the cash paid when bonds are issued at a premium. Explain this to Geoff.