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Chapter 14: Q7E (page 755)

(Amortization Schedule鈥擡ffective-Interest) Assume the same information as E14-6.

Instructions

Set up a schedule of interest expense and discount amortization under the effective-interest method. (Hint: The effective-interest rate must be computed.)

Short Answer

Expert verified

The effective interest rate is12%.

Step by step solution

01

Definition of Discount Amortization

Discount amortization is the method used by the business entity that has issued its bonds at a discount to spread the discount value over the life of the bond. The discount can be amortized by using the effective interest method or by using the straight-line method of amortization.

02

Amortization table under effective interest method

Date

Cash interest paid at stated rate on bond payable (10%)

Interest expenses at market rate on book value of bonds (12%)

Discount amortized

Unamortized discount

Bond payable

Book value

1 Jan 2017

$144,184

$2,000,000

$1,855,816

1 Jan 2018

$200,000

$222,698

$22,698

$121,486

$2,000,000

$1,878,514

1 Jan 2019

$200,000

$225,422

$25,422

$96,064

$2,000,000

$1,974,578

1 Jan 2020

$200,000

$236,949

$36,949

$59,115

$2,000,000

$2,033,693

1 Jan 2021

$200,000

$244,043

$44,043

$15,072

$2,000,000

$2,015,072

1 Jan 2022

$200,000

$241,809

$41,809

$0

$2,000,000

$200,000

Note: The present value calculated under 12% is nearer to the issue price of the bonds.

Working note: Calculation of effective interest rate

Calculation of present value at 11%:

Particular

Amount $

Present value of the bonds payable $2,000,000 (n=5, r=11%) (0.5935)

$1,187,000

Present value of the interest $200,000 (n=5, r=11%) (3.70)

740,000

Total present value

$1,927,000

Calculation of present value at 12%:

Particular

Amount $

Present value of the bonds payable $2,000,000 (n=5, r=12%) (0.5674)

$1,134,800

Present value of the interest $200,000 (n=5, r=12%) (3.605)

721,000

Total present value

$1,855,800

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Most popular questions from this chapter

How is the present value of a non-interest-bearing note computed?

(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.

On January 1, 2017, Ellen Carter Company makes the two following acquisitions.

  1. Purchases land having a fair value of \(200,000 by issuing a 5-year, zero-interest-bearing promissory note in the face amount of \)337,012.
  2. Purchases equipment by issuing a 6%, 8-year promissory note having a maturity value of $250,000 (interest payable annually).

The company has to pay 11% interest for funds from its bank

Instructions

(Round answers to the nearest cent.)

  1. Record the two journal entries that should be recorded by Ellen Carter Company for the two purchases on January 1, 2017.
  2. Record the interest at the end of the first year on both notes using the effective-interest method.

Describe the two criteria for determining the valuation of financial assets.

On December 31, 2017, American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, \(3,000,000 note receivable by the following modifications:

  1. Reducing the principal obligation from \)3,000,000 to \(2,400,000.
  2. Extending the maturity date from December 31, 2017, to January 1, 2021.
  3. Reducing the interest rate from 12% to 10%.

Barkley pays interest at the end of each year. On January 1, 2021, Barkley Company pays \)2,400,000 in cash to American Bank.

Instructions

  1. Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring?
  2. Can Barkley Company record a gain under the term modification mentioned above? Explain.
  3. Assuming that the interest rate Barkley should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.
  4. Prepare the interest payment entry for Barkley Company on December 31, 2019.
  5. What entry should Barkley make on January 1, 2021?
See all solutions

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