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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

All of the following are differences between IFRS and GAAP in accounting for liabilities except:

a) When a bond is issued at a discount, GAAP records the discount in a separate contra liability account. IFRS records the bond net of the discount.

b) Under IFRS, bond issuance costs reduce the carrying value of the debt. Under GAAP, these costs are recorded as an asset and amortized to expense over the terms of the bond.

c) GAAP, but not IFRS, uses the term 鈥渢roubled-debt restructurings.鈥�

d) GAAP, but not IFRS, uses the term 鈥減rovisions鈥� for contingent liabilities which are accrued.

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, \(1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2018, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its \)10 par value common stock. At this time, the accrued interest was paid in cash. The company鈥檚 stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)

Distinguish between the following interest rates for bonds payable:

(a)Yield rate

(b) Nominal Rate

(c) Stated rate

(d) Market rate

(e) Effective rate

Using the same information as in E14-22, answer the following questions related to American Bank (creditor).

Instructions

  1. What interest rate should American Bank use to calculate the loss on the debt restructuring?
  2. Compute the loss that American Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss.
  3. Prepare the interest receipt schedule for American Bank after the debt restructuring.
  4. Prepare the interest receipt entry for American Bank on December 31, 2019.
  5. What entry should American Bank make on January 1, 2021?

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.
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