Info from E13 3 Assume that on January 1 2005 a company issues bonds The bonds

Info from e13 3 assume that on january 1 2005 a

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(Info from E13-3): Assume that on January 1, 2005, a company issues bonds. The bonds are dated January 1, 2005, and have a face amount of $1,000,000. Interest will be paid at the rate of 8 percent semiannually for five years. The bonds are issued for $1,041,583. SKIP THIS PART - YOU WILL NOT BE ASKED TO To calculate the yield on bonds. CALCULATE YIELDS ON BONDS Interest yield on bonds: Interest payments: $1,000,000 × 8% × 6/12 = $40,000 Present value of principal for N = 10; I = 3.5% $ 708,919 Present value of interest for N = 10; I = 3.5% 332,664 Market value $1,041,583 Interest yield: 0.035 × 2 = 7.0% Required: 1 Calculate the amount of premium that should be amortized each period if the company uses the straight-line method. 01/01/05 $1,041,583 06/30/05 $40,000 $35,842 $4,158 1,037,425 12/31/05 40,000 35,842 4,158 1,033,266 06/30/06 40,000 35,842 4,158 1,029,108 12/31/06 40,000 35,842 4,158 1,024,950 06/30/07 40,000 35,842 4,158 1,020,792 12/31/07 40,000 35,842 4,158 1,016,633 06/30/08 40,000 35,842 4,158 1,012,475 12/31/08 40,000 35,842 4,158 1,008,317 06/30/09 40,000 35,842 4,158 1,004,158 12/31/09 40,000 35,842 4,158 1,000,000 *Rounded Premium Amortization: ($1,041,583 - $1,000,000) = $41,583 $41,583 (amount of premium)/ 5 years = 8316.6 a year $8316/2 (number of compounding periods) = $4,158 per 6 month period. Remember, when we amortize a premium, we are reducing the carrying value Date Cash Interest Expense Premium Amortization Bond Carrying Value *
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of the bond. 2 Develop an amortization table that can be used to amortize the bond premium if the company uses the effective interest method. Prepare the journal entries that should be recorded on June 30, 2005, and December 31, 2005. Effective interest method: 01/01/05 $1,041,583 06/30/05 $40,000 $36,455 $3,545 1,038,038 12/31/05 40,000 $36,331 $3,669 1,034,370 06/30/06 40,000 $36,203 $3,797 1,030,573 12/31/06 40,000 $36,070 $3,930 1,026,643 06/30/07 40,000 $35,932 $4,068 1,022,575 12/31/07 40,000 $35,790 $4,210 1,018,365 06/30/08 40,000 $35,643 $4,357 1,014,008 12/31/08 40,000 $35,490 $4,510 1,009,498 06/30/09 40,000 $35,332 $4,668 1,004,831 12/31/09 40,000 $35,169 $4,831 1,000,000 *Rounded Yield was determined to be 7%. (see E13-3). Half of that is 3.5%. DATE DESCRIPTION DEBIT CREDIT 06/30/05 Interest Expense 36,455 Premium on Bonds 3,545 Cash 40,000 12/31/05 Interest Expense 36,331 Premium on Bonds 3,669 Cash 40,000 3 For each semiannual period over the life of the bonds, calculate interest as a percentage of bond carrying value (interest expenses/bond carrying value) for the straight-line and effective interest methods. Explain why the effective interest method is considered to be the better Straight-line method: Date Cash Interest Expense (BCV *3.5%) Premium Amortization (Cash - Interest Expense) Bond Carrying Value method theoretically. SKIP THIS PART *
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06/30/05 $35,842 $1,041,583 3.441% 12/31/05 35,842 1,037,425 3.455% 06/30/06 35,842 1,033,266 3.469% 12/31/06 35,842 1,029,108 3.483% 06/30/07 35,842 1,024,950 3.497% 12/31/07 35,842 1,020,792 3.511% 06/30/08 35,842 1,016,633 3.526% 12/31/08 35,842 1,012,475 3.540% 06/30/09 35,842 1,008,317 3.555% 12/31/09 35,842 1,004,158 3.569% Effective interest method: 06/30/05 $36,455 $1,041,583 3.50% 12/31/05 36,331 1,038,038 3.50% 06/30/06 36,203 1,034,370 3.50% 12/31/06 36,070 1,030,573 3.50% 06/30/07 35,932 1,026,643 3.50% 12/31/07 35,790 1,022,575 3.50% 06/30/08 35,643 1,018,365 3.50% 12/31/08 35,490 1,014,008 3.50% 06/30/09 35,332 1,009,498 3.50% 12/31/09 35,169 1,004,831 3.50% Date Interest Carrying Value Percent of Carrying Value Date Interest Carrying Value Percent of Carrying Value
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Exercise 13-7 Gain or Loss - Redemption on an Interest Date Refer to the facts in Exercises 13-3 and 13-5. Assume that the bonds are redeemed on December 31, 2005, at 102. Required: 1 Determine the amount of gain or loss on bond redemption using both the straight-line and effective interest methods of amortization. (You may ignore income taxes).
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