Blueprint Problem: Bonds - Issued at Premium Bonds When a company requires more cash than it currently has, it can acquire this cash very quickly through the issuance of a bond. When a bond is issued, it must first be authorized by the U. S. Securities and Exchange Commission (SEC). The terms of the bond are laid out in the bond indenture, and bondholders are given a bond certificate as proof of ownership over the debt. A bond is a form of debt, so issuing a bond immediately increases both on the When a corporation issues bonds, the proceeds received for the bonds depend on the following: 1. The face amount of the bonds, which is the amount due at the maturity date. 2. The stated interest rate on the bonds. 3. The market interest rate of interest. If an individual bond is worth $5,000 and it is one of 1,000 bonds in its associated issuance, what is the bond issue? $ A bond issued at 103 is issued at: At Par Discount Premium If the company issues the bonds with an 8% interest rate and bonds of similar risk are paying 7% interest, assess the following: Market interest rate: % Coupon interest rate: % Bonds Issued at a Premium Assume that a company issues a bond at 113 having a face value of $2,000 and a coupon interest rate of 9%. The bond pays interest annually, has a five-year maturity time frame, and bonds of similar risk are currently paying interest rates of 6%. The bond's issue price would be $ , it would make an annual interest payment on the bond in the amount of $ , and at the end of five years would pay back the principal of $ . The total premium on the bond is $ . Because bonds issued at a premium result in the company receiving more money up front, the bonds are actually costing the company less than just the periodic interest payments. For this reason, total interest expense equals the total interest paid over the life of the bond less the total premium on the bond. Total interest expense on this bond is $ . APPLY THE CONCEPTS: Calculate the selling price of a bond Bond indenture Issue Date: 1/1/2011 Face value: $100,000 Coupon interest rate: 7% annually Maturity date: 12/31/2013 Additional information The market interest rate for bonds of similar risk is 6%. Interest is paid out on an annual basis. The market price of the bond has yet to be determined. Click here to open an illustrated example of the process. + Click here for open the table for the Present Value of a Single Amount + Click here for open the table for the Present Value of an Ordinary Annuity Part 1: Calculate the present value of the face amount to be received at maturity. Future Value: $100,000 Year 1 Year 2 Year 3 Present value of the face amount: $ + Part 2: Calculate the present value of the interest payments to be paid out periodically. Payment: $7,000 Payment: $7,000 Payment: $7,000 Year 1 Year 2 Year 3 Present value of interest payments to be distributed: $ Part 3: Add the figures calculated in Parts 1 and 2 together. Selling price of the bond = $ Calculate the total premium on bonds payable to be amortized over the life of the bond: Bond Selling Price Face Value = $ Hide APPLY THE CONCEPTS: Journalize the issuance of the bonds When bonds are issued at a premium, cash is received, a liability is created, and the difference between them is the premium on bonds payable, which is amortized over the bond's life. Journalize the bond transactions and indicate what effect, if any, they have on the accounting equation. If an amount box does not require an entry, leave it blank or enter "0". Not sure about the account title? Click here to view the chart of accounts. + Assets + Liabilities + Equity + Revenues/Gains + Expenses/Losses GENERAL JOURNAL page DATE DESCRIPTION DOC. NO. POST. REF. DEBIT CREDIT 1 Jan 1 2011 Bonds Payable 1 2 Cash 2 3 Interest Expense 3 Indicate the effect, if any, the journal entry has on the accounting equation. Accounting equation Row Assets = Liabilities + Equity Row 1 Row 2 Row 3 Note: If required, round to the nearest cent. Calculate cash payment: Coupon Interest Rate x Face Value = $ Calculate premium on bonds payable to be amortized in the current period using the straight-line method: Total Premium on Bond Payable / Periods = $ Calculate interest expense: Cash Payment Premium Amortized in the Current Period = $ Hide Record the first year's interest expense, associated amortization of bond premium, and distribution of cash. If required, round to the nearest cent. If an amount box does not require an entry, leave it blank or enter "0". GENERAL JOURNAL page DATE DESCRIPTION DOC. NO. POST. REF. DEBIT CREDIT 1 Dec 31 2011 Bonds Payable 1 2 Bonds Payable 2 3 Bonds Payable 3 Indicate the effect, if any, the journal entry has on the accounting equation. Row Assets = Liabilities + Equity Row 1 Row 2 Row 3 Hide Record the second year's interest expense, associated amortization of bond premium, and distribution of cash. This is straight-line amortization, so this year's calculations will be identical to last year's. If required, round to the nearest cent. If an amount box does not require an entry, leave it blank or enter "0". GENERAL JOURNAL page DATE DESCRIPTION DOC. NO. POST. REF. DEBIT CREDIT 1 Dec. 31 2012 1 2 Bonds Payable 2 3 Bonds Payable 3 Indicate the effect, if any, the journal entry has on the accounting equation. Row Assets = Liabilities + Equity Row 1 Row 2 Row 3 Hide On the last day of the final year in the bond's life, record the final entry of interest expense, final amortization of bond premium, and cash disbursement. Also, because this is the last year of the bond's life, you must also pay out the principal of the bond and extinguish the associated liability. Compute premium amortization before interest expense. Due to rounding differences, compute the premium amortization as follows: Total premium originally computed less all premium amortization recorded previously. If required, enter answers as dollars and cents. If an amount box does not require an entry, leave it blank or enter "0". GENERAL JOURNAL page DATE DESCRIPTION DOC. NO. POST. REF. DEBIT CREDIT 1 Dec. 31 2013 Accounts Payable 1 2 Cash 2 3 Bonds Payable 3 4 To record interest expense 4 5 5 6 Dec. 31 2013 Bonds Payable 6 7 Bonds Payable 7