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Chapter 12: 2RQ (page 654)
What is an amortization schedule?
Amortization is a process by which thw amount of the liability is decreased with the help of regular payments.
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Describing bonds, journalizing transactions for bonds payable using the straight-line amortization method, and journalizing transactions for a mortgage payable
This problem continues the Canyon Canoe Company situation from Chapter 11. Canyon Canoe Company is considering raising additional capital for further expansion. The company wants to finance a new business venture into guided trips down the Amazon River in South America. Additionally, the company wants to add another building on their land to offer more services for local customers. Canyon Canoe Company plans to raise the capital by issuing \(210,000 of 7.5%, six-year bonds on January 2, 2020. The bonds pay interest semiannually on June 30 and December 31. The company receives \)208,476 when the bonds are issued.
The company also issues a mortgage payable for \(450,000 on January 2, 2020. The proceeds from the mortgage will be used to construct the new building. The mortgage requires annual payments of \)45,000 plus interest for ten years, payable on December 31. The mortgage interest rate is 8%.
Requirements
1. Will the bonds issue at face value, a premium, or a discount?
2. Record the following transactions. Include dates and round to the nearest dollar. Omit explanations.
a. Cash received from the bond issue.
b. Cash received from the mortgage payable.
c. Semiannual bond interest payments for 2020. Amortize the premium or discount using the straight-line amortization method.
d. Payment on the mortgage payable for 2020.
3. Calculate the total interest expense incurred in 2020.
Analyzing and journalizing bond transactions
On January 1, 2018, Educators Credit Union (ECU) issued 8%, 20-year bonds payablewith face value of $1,000,000. These bonds pay interest on June 30 and December 31.The issue price of the bonds is 109.Journalize the following bond transactions:
a. Issuance of the bonds on January 1, 2018.
b. Payment of interest and amortization on June 30, 2018.
c. Payment of interest and amortization on December 31, 2018.
d. Retirement of the bond at maturity on December 31, 2037, assuming the lastinterest payment has already been recorded.
Bill and Edna had been married two years and had just reached the point where they
had enough savings to start investing. Bill鈥檚 uncle Dave told them that he had recently
inherited some very rare railroad bonds from his grandmother鈥檚 estate. He wanted
to help Bill and Edna get a start in the world and would sell them 50 of the bonds at
\(100 each. The bonds were dated 1873, beautifully engraved, showing a face value of
\)1,000 each. Uncle Dave pointed out that 鈥淯nited States of America鈥� was printed
prominently at the top and that the U.S. government had established a sinking fund to
retire the old railroad bonds. A sinking fund is a fund established for the purpose of
repaying the debt. It allows the organization (the U.S. government, in this example)
to set aside money over time to retire the bonds. All Bill and Edna needed to do was
hold on to them until the government contacted them, and they would eventually get
the full \(1,000 for each bond. Bill and Edna were overjoyed鈥攗ntil a year later when
they saw the exact same bonds for sale at a coin and stamp shop priced as 鈥渃ollectors鈥�
items鈥� for \)9.95 each!
Requirements
1. If a company goes bankrupt, what happens to the bonds it issued and the investorswho bought the bonds?
2. When investing in bonds, how can you tell whether the bond issue is a legitimatetransaction?
3. Is there a way to determine the relative risk of corporate bonds?
S12A-13 Determining present value
Your grandfather would like to share some of his fortune with you. He offers to give
you money under one of the following scenarios (you get to choose):
2. \)49,650 (lump sum) now
3. $100,450 (lump sum) six years from now
C H A P T E R 1 2
Requirements
1. Calculate the present value of each scenario using a 6% discount rate. Which scenario
yields the highest present value? Round to the nearest dollar.
2. Would your preference change if you used a 12% discount rate?
When a bond is issued, what is its present value?
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