Problem Two cont...

On January 1, 2017, Ashlock Chemical AG issued 4,000,000, 10%, 10-year bonds at 4,543,627. This price resulted in an 8% effective-interest rate on the bonds. Ashlock uses the effective-interest method to amortize bond premium or discount. The bonds pay interest semi-annually on January 1 and July 1. Rounding to two decimal places, answer the following:

a) Use Present Value of 1 Table and Present Value of an Annuity of 1 Table, and your knowledge of time value of money, to prove why the bonds were issued at $4,543,626. Then prepare the JE for the issuance on January 1, 2017. If your calculations differ due to rounding, use the $4,543,626 figure for the issuance JE and the subsequent requirements. (Special side note: if interest were paid annually, the textbook figure of $4,543,626 would be incorrect. Assuming annual interest payments, the PV would be $4,536,792! (You may want to prove this on your own.)

b) Assuming the bonds are redeemed at maturity, what is the total amount of interest expense to be recognized over the life of the bonds? Show your work.

c) Assume the company has an annual accounting period ending the end of February.

1. Prepare the AJE required on February 28, 2017.

2. Prepare the journal entry to record the payment of interest on July 1, 2017

d) Ignore (c). Assume the annual accounting period ends on December 31 instead.

1.Prepare the journal entry to record the payment of interest on July 1, 2017.

2. Prepare the AJE required on December 31, 2017

3.Prepare the journal entry to record the payment of interest on January 1, 2018.

4. What is the carrying value of the bonds on January 1, 2018? Show your calculations

e) Assume that after interest is paid on January 1, 2018, the company buys back the bonds. On that date, the market interest rate was 12%.

1.Calculate what the company must pay to redeem the bonds. (Hint: This requires time value of money calculations.)

2.Prepare the journal entry to record the redemption.

3.Using a residual analysis, explain why a gain/loss must be recognized; also explain where on the SOCI the gain/loss would appear.

4.Assume a gain was realised. Assess the immediate impact on the debt/asset ratio. What will be the impact on the interest cover ratio for the financial year ending December 31, 2018 (compared with the previous financial year)?