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Chapter 14: Q11P (page 762)

(Effective-Interest Method) Samantha Cordelia, an intermediate accounting student, is having difficulty amortizing bond premiums and discounts using the effective-interest method. Furthermore, she cannot understand why GAAP requires that this method be used instead of the straight-line method. She has come to you with the following problem, looking for help.

On June 30, 2017, Hobart Company issued \(2,000,000 face value of 11%, 20-year bonds at \)2,171,600, a yield of 10%. Hobart Company uses the effective-interest method to amortize bond premiums or discounts. The bonds pay semiannual interest on June 30 and December 31. Prepare an amortization schedule for four periods.

Short Answer

Expert verified

The balance of the unamortized schedule on 30 June 2019 is$165,479.

Step by step solution

01

Definition of Bond Amortization

Bond amortization refers to a method used by the business entity to spread the discount or the premium on the bonds payable over its life. Generally, two bond amortization methods are straight-line and effective interest methods.

02

Amortization Schedule

Date

Interest payment at the stated rate on face value (5.5%)

Interest expenses at the market rate on the previous year book value (5%)

Amortized premium

Unamortized premium

Bond payable

Book value of bond payable

30 June 2017

$171,600

$2,000,000

$2,171,600

31 Dec 2017

$110,000

$108,580

$1,420

$170,180

$2,000,000

$2,170,180

30 June 2018

$110,000

$108,509

$1,491

$168,689

$2,000,000

$2,168,689

31 Dec 2018

$110,000

$108,434

$1,566

$167,123

$2,000,000

$2,167,123

30 June 2019

$110,000

$108,356

$1,644

$165,479

$2,000,000

$2,165,479

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Most popular questions from this chapter

Coldwell, Inc. issued a \(100,000. 4-years, 10% note at face value to Flint Hills Bank on January 1, 2017, and received \)100,000 cash. The note requires annual interest payments each December 31. Prepare Coldwell鈥檚 journal entries to record (a) the issuance of the note and (b) the December 31 interest payment.

Question: Will the amortization of Discount on Bonds Payable increase or decrease Bond Interest Expense? Explain.

Shonen Knife Corporation has elected to use the fair value option for one of its notes payable. The note was issued at an effective rate of 11% and has a carrying value of \(16,000. At year-end, Shonen Knife鈥檚 borrowing rate (credit risk) has declined; the fair value of the note payable is now \)17,500. (a) Determine the unrealized holding gain or loss on the note. (b) Prepare the entry to record any unrealized holding gain or loss.

(Debtor/Creditor Entries for Continuation of Troubled Debt) Daniel Perkins is the sole shareholder of Perkins Inc., which is currently under protection of the U.S. bankruptcy court. As a 鈥渄ebtor in possession,鈥� he has negotiated the following revised loan agreement with United Bank. Perkins Inc.鈥檚 \(600,000, 12%, 10-year note was refinanced with a \)600,000, 5%, 10-year note.

Instructions

(a) What is the accounting nature of this transaction?

(b) Prepare the journal entry to record this refinancing:

(1) On the books of Perkins Inc.

(2) On the books of United Bank.

(c) Discuss whether generally accepted accounting principles provide the proper information useful to managers and investors in this situation.

Matt Ryan Corporation is interested in building its own soda can manufacturing plant adjacent to its existing plant in Partyville, Kansas. The objective would be to ensure a steady supply of cans at a stable price and to minimize transportation costs. However, the company has been experiencing some financial problems and has been reluctant to borrow any additional cash to fund the project. The company is not concerned with the cash flow problems of making payments, but rather with the impact of adding additional long-term debt to its balance sheet.

The president of Ryan, Andy Newlin, approached the president of the Aluminum Can Company (ACC), its major supplier, to see if some agreement could be reached. ACC was anxious to work out an arrangement, since it seemed inevitable that Ryan would begin its own can production. The Aluminum Can Company could not afford to lose the account.

After some discussion, a two-part plan was worked out. First, ACC was to construct the plant on Ryan鈥檚 land adjacent to the existing plant. Second, Ryan would sign a 20-year purchase agreement. Under the purchase agreement, Ryan would express its intention to buy all of its cans from ACC, paying a unit price which at normal capacity would cover labor and material, an operating management fee, and the debt service requirements on the plant. The expected unit price, if transportation costs are taken into consideration, is lower than current market. If Ryan did not take enough production in any one year and if the excess cans could not be sold at a high enough price on the open market, Ryan agrees to make up any cash shortfall so that ACC could make the payments on its debt. The bank will be willing to make a 20-year loan for the plant, taking the plant and the purchase agreement as collateral. At the end of 20 years, the plant is to become the property of Ryan.

Instructions

  1. What are project financing arrangements using special-purpose entities?
  2. What are take-or-pay contracts?
  3. Should Ryan record the plant as an asset together with the related obligation?
  4. If not, should Ryan record an asset relating to the future commitment?
  5. What is meant by off-balance-sheet financing?
See all solutions

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