Question
On the first day of its fiscal year, Ebert Company issued $12,500,000 of 10-year, 7% bonds to finance its operations. Interest is payable semiannually. The
On the first day of its fiscal year, Ebert Company issued $12,500,000 of 10-year, 7% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 9%, resulting in Ebert receiving cash of $10,873,974. The company uses the interest method.
Required:
a. Journalize the entries to record the following transactions. Refer to the Chart of Accounts for exact wording of account titles.
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b. Compute the amount of the bond interest expense for the first year. | |||||||
c. Explain why the company was able to issue the bonds for only $10,873,974 rather than for the face amount of $12,500,000. |
Two present value tables are provided: Present Value of $1 at Compound Interest Due in n Periods and Present Value of Ordinary Annuity of $1 per Period. Use them as directed in the problem requirements.
Present Value of $1 at Compound Interest Due in n Periods | |||||||
Periods | 4.0% | 4.5% | 5% | 5.5% | 6% | 6.5% | 7% |
1 | 0.96154 | 0.95694 | 0.95238 | 0.94787 | 0.94340 | 0.93897 | 0.93458 |
2 | 0.92456 | 0.91573 | 0.90703 | 0.89845 | 0.89000 | 0.88166 | 0.87344 |
3 | 0.88900 | 0.87630 | 0.86384 | 0.85161 | 0.83962 | 0.82785 | 0.81630 |
4 | 0.85480 | 0.83856 | 0.82270 | 0.80722 | 0.79209 | 0.77732 | 0.76290 |
5 | 0.82193 | 0.80245 | 0.78353 | 0.76513 | 0.74726 | 0.72988 | 0.71299 |
6 | 0.79031 | 0.76790 | 0.74622 | 0.72525 | 0.70496 | 0.68533 | 0.66634 |
7 | 0.75992 | 0.73483 | 0.71068 | 0.68744 | 0.66506 | 0.64351 | 0.62275 |
8 | 0.73069 | 0.70319 | 0.67684 | 0.65160 | 0.62741 | 0.60423 | 0.58201 |
9 | 0.70259 | 0.67290 | 0.64461 | 0.61763 | 0.59190 | 0.56735 | 0.54393 |
10 | 0.67556 | 0.64393 | 0.61391 | 0.58543 | 0.55839 | 0.53273 | 0.50835 |
11 | 0.64958 | 0.61620 | 0.58468 | 0.55491 | 0.52679 | 0.50021 | 0.47509 |
12 | 0.62460 | 0.58966 | 0.55684 | 0.52598 | 0.49697 | 0.46968 | 0.44401 |
13 | 0.60057 | 0.56427 | 0.53032 | 0.49856 | 0.46884 | 0.44102 | 0.41496 |
14 | 0.57748 | 0.53997 | 0.50507 | 0.47257 | 0.44230 | 0.41410 | 0.38782 |
15 | 0.55526 | 0.51672 | 0.48102 | 0.44793 | 0.41727 | 0.38883 | 0.36245 |
16 | 0.53391 | 0.49447 | 0.45811 | 0.42458 | 0.39365 | 0.36510 | 0.33873 |
17 | 0.51337 | 0.47318 | 0.43630 | 0.40245 | 0.37136 | 0.34281 | 0.31657 |
18 | 0.49363 | 0.45280 | 0.41552 | 0.38147 | 0.35034 | 0.32189 | 0.29586 |
19 | 0.47464 | 0.43330 | 0.39573 | 0.36158 | 0.33051 | 0.30224 | 0.27651 |
20 | 0.45639 | 0.41464 | 0.37689 | 0.34273 | 0.31180 | 0.28380 | 0.25842 |
21 | 0.43883 | 0.39679 | 0.35894 | 0.32486 | 0.29416 | 0.26648 | 0.24151 |
22 | 0.42196 | 0.37970 | 0.34185 | 0.30793 | 0.27751 | 0.25021 | 0.22571 |
23 | 0.40573 | 0.36335 | 0.32557 | 0.29187 | 0.26180 | 0.23494 | 0.21095 |
24 | 0.39012 | 0.34770 | 0.31007 | 0.27666 | 0.24698 | 0.22060 | 0.19715 |
25 | 0.37512 | 0.33273 | 0.29530 | 0.26223 | 0.23300 | 0.20714 | 0.18425 |
26 | 0.36069 | 0.31840 | 0.28124 | 0.24856 | 0.21981 | 0.19450 | 0.17220 |
27 | 0.34682 | 0.30469 | 0.26785 | 0.23560 | 0.20737 | 0.18263 | 0.16093 |
28 | 0.33348 | 0.29157 | 0.25509 | 0.22332 | 0.19563 | 0.17148 | 0.15040 |
29 | 0.32065 | 0.27902 | 0.24295 | 0.21168 | 0.18456 | 0.16101 | 0.14056 |
30 | 0.30832 | 0.26700 | 0.23138 | 0.20064 | 0.17411 | 0.15119 | 0.13137 |
31 | 0.29646 | 0.25550 | 0.22036 | 0.19018 | 0.16425 | 0.14196 | 0.12277 |
32 | 0.28506 | 0.24450 | 0.20987 | 0.18027 | 0.15496 | 0.13329 | 0.11474 |
33 | 0.27409 | 0.23397 | 0.19987 | 0.17087 | 0.14619 | 0.12516 | 0.10723 |
34 | 0.26355 | 0.22390 | 0.19035 | 0.16196 | 0.13791 | 0.11752 | 0.10022 |
35 | 0.25342 | 0.21425 | 0.18129 | 0.15352 | 0.13011 | 0.11035 | 0.09366 |
40 | 0.20829 | 0.17193 | 0.14205 | 0.11746 | 0.09722 | 0.08054 | 0.06678 |
45 | 0.17120 | 0.13796 | 0.11130 | 0.08988 | 0.07265 | 0.05879 | 0.04761 |
50 | 0.14071 | 0.11071 | 0.08720 | 0.06877 | 0.05429 | 0.04291 | 0.03395 |
Present Value of Ordinary Annuity of $1 per Period | |||||||
Periods | 4.0% | 4.5% | 5% | 5.5% | 6% | 6.5% | 7% |
1 | 0.96154 | 0.95694 | 0.95238 | 0.94787 | 0.94340 | 0.93897 | 0.93458 |
2 | 1.88609 | 1.87267 | 1.85941 | 1.84632 | 1.83339 | 1.82063 | 1.80802 |
3 | 2.77509 | 2.74896 | 2.72325 | 2.69793 | 2.67301 | 2.64848 | 2.62432 |
4 | 3.62990 | 3.58753 | 3.54595 | 3.50515 | 3.46511 | 3.42580 | 3.38721 |
5 | 4.45182 | 4.38998 | 4.32948 | 4.27028 | 4.21236 | 4.15568 | 4.10020 |
6 | 5.24214 | 5.15787 | 5.07569 | 4.99553 | 4.91732 | 4.84101 | 4.76654 |
7 | 6.00205 | 5.89270 | 5.78637 | 5.68297 | 5.58238 | 5.48452 | 5.38929 |
8 | 6.73274 | 6.59589 | 6.46321 | 6.33457 | 6.20979 | 6.08875 | 5.97130 |
9 | 7.43533 | 7.26879 | 7.10782 | 6.95220 | 6.80169 | 6.65610 | 6.51523 |
10 | 8.11090 | 7.91272 | 7.72173 | 7.53763 | 7.36009 | 7.18883 | 7.02358 |
11 | 8.76048 | 8.52892 | 8.30641 | 8.09254 | 7.88687 | 7.68904 | 7.49867 |
12 | 9.38507 | 9.11858 | 8.86325 | 8.61852 | 8.38384 | 8.15873 | 7.94269 |
13 | 9.98565 | 9.68285 | 9.39357 | 9.11708 | 8.85268 | 8.59974 | 8.35765 |
14 | 10.56312 | 10.22283 | 9.89864 | 9.58965 | 9.29498 | 9.01384 | 8.74547 |
15 | 11.11839 | 10.73955 | 10.37966 | 10.03758 | 9.71225 | 9.40267 | 9.10791 |
16 | 11.65230 | 11.23402 | 10.83777 | 10.46216 | 10.10590 | 9.76776 | 9.44665 |
17 | 12.16567 | 11.70719 | 11.27407 | 10.86461 | 10.47726 | 10.11058 | 9.76322 |
18 | 12.65930 | 12.15999 | 11.68959 | 11.24607 | 10.82760 | 10.43247 | 10.05909 |
19 | 13.13394 | 12.59329 | 12.08532 | 11.60765 | 11.15812 | 10.73471 | 10.33560 |
20 | 13.59033 | 13.00794 | 12.46221 | 11.95038 | 11.46992 | 11.01851 | 10.59401 |
21 | 14.02916 | 13.40472 | 12.82115 | 12.27524 | 11.76408 | 11.28498 | 10.83553 |
22 | 14.45112 | 13.78442 | 13.16300 | 12.58317 | 12.04158 | 11.53520 | 11.06124 |
23 | 14.85684 | 14.14777 | 13.48857 | 12.87504 | 12.30338 | 11.77014 | 11.27219 |
24 | 15.24696 | 14.49548 | 13.79864 | 13.15170 | 12.55036 | 11.99074 | 11.46933 |
25 | 15.62208 | 14.82821 | 14.09394 | 13.41393 | 12.78336 | 12.19788 | 11.65358 |
26 | 15.98277 | 15.14661 | 14.37519 | 13.66250 | 13.00317 | 12.39237 | 11.82578 |
27 | 16.32959 | 15.45130 | 14.64303 | 13.89810 | 13.21053 | 12.57500 | 11.98671 |
28 | 16.66306 | 15.74287 | 14.89813 | 14.12142 | 13.40616 | 12.74648 | 12.13711 |
29 | 16.98371 | 16.02189 | 15.14107 | 14.33310 | 13.59072 | 12.90749 | 12.27767 |
30 | 17.29203 | 16.28889 | 15.37245 | 14.53375 | 13.76483 | 13.05868 | 12.40904 |
31 | 17.58849 | 16.54439 | 15.59281 | 14.72393 | 13.92909 | 13.20063 | 12.53181 |
32 | 17.87355 | 16.78889 | 15.80268 | 14.90420 | 14.08404 | 13.33393 | 12.64656 |
33 | 18.14765 | 17.02286 | 16.00255 | 15.07507 | 14.23023 | 13.45909 | 12.75379 |
34 | 18.41120 | 17.24676 | 16.19290 | 15.23703 | 14.36814 | 13.57661 | 12.85401 |
35 | 18.66461 | 17.46101 | 16.37419 | 15.39055 | 14.49825 | 13.68696 | 12.94767 |
40 | 19.79277 | 18.40158 | 17.15909 | 16.04612 | 15.04630 | 14.14553 | 13.33171 |
45 | 20.72004 | 19.15635 | 17.77407 | 16.54773 | 15.45583 | 14.48023 | 13.60552 |
50 | 21.48218 | 19.76201 | 18.25593 | 16.93152 | 15.76186 | 14.72452 | 13.80075 |
ANSWER THESE:
b. Compute the amount of the bond interest expense for the first year.
Annual interest paid | |
Plus discount amortized | |
Interest expense for first year |
FINAL QUESTION:
Explain why the company was able to issue the bonds for only $10,873,974 rather than for the face amount of $12,500,000.
The bonds sell for less than their face amount because the market rate of interest is the contract rate of interest. Investors willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).
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