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Chapter 22, End of Chapter, Self-Study Demonstration Problem, Exercise 1

# Brooks Inc.'s fiscal year ends December 31. Selected transactions for the period 20-1 through 20-8 involving bonds payable issued by Brooks are as follows: 20-1  Nov. 30 Issued \$800,000 of 10-year, 9%, callable bonds dated November 30, 20-1, for \$776,000. Interest is payable semiannually on November 30 and May 31. The bond indenture provides that Brooks is to pay to the trustee bank \$30,000 by June 15 of each year (except the tenth year) as a sinking fund for the retirement of the bonds on call or at maturity.Dec. 31 Made the adjusting entry for interest payable and amortized one month's discount on the bonds (straight-line method).20-2  Jan. 2 Reversed the adjusting entry for interest payable and bond discount amortization.May 31 Paid the semiannual interest on the bonds and amortized six months' discount.June 15 Paid the sinking fund trustee \$30,000.Nov. 30 Paid the semiannual interest on the bonds and amortized six months' discount.Dec. 31 Made the adjusting entry for interest payable and amortized one month's discount on the bonds.31 Sinking fund earnings for the year were \$1,100.20-8  June 15 Paid the sinking fund trustee \$30,000.Nov. 30 Paid the semiannual interest on the bonds and amortized six months' discount.30 Redeemed the bonds, which were called at 102. The balance in the bond discount account is \$7,200 after the payment of interest and amortization of discount have been entered. The cash balance in the sinking fund is \$320,000. The sinking fund trustee is paid the additional cash needed to redeem the bonds. ( Hint: First make the entry for payment to the sinking fund, then make the entry for redemption of the bonds.) Enter the transactions in general journal form.

### Explanation

Year 20-1:

November 30

The company only receives \$776,000 from a bond with a face value of \$800,000.  The difference of \$24,000 is recorded as a discount on bonds payable which is a debit account.

December 31

Since one month has already passed, the applicable interest expense and amortization of discount on bonds payable must be recorded as an adjusting entry.  The calculation is as follows

Amortization of discount on bonds payable increases the interest expense; thus, total bond interest expense amounts to \$6,200.

Year 20-2:

January 2

The reversing entry is made in order to cancel the adjusting entry recorded in the prior year.  This reduces the interest expense and amortization of discount by one month during the first interest payment in May.  This results in the correct net recognition of only 5-month interest expense and amortization of discount from January to May.

May 31

Multiply the monthly interest expense of \$6,000 and monthly amortization of discount on bonds payable of \$200 by 6 months to get the semiannual interest payment.  Add the two results to get the total bond interest expense.

While 6 months are recorded for the interest expense in May, the company only recognizes interest expense for 5 months since there is already a reversing entry made on January 2 for the one-month interest expense.

June 15

The company maintains a bond sinking fund to pay the bonds payable upon maturity or upon callable period.  Bond sinking fund is an asset; thus, it is recorded as a debit account while crediting a cash account.

November 30

The company makes the second interest payment.  Please refer to the calculation in May above for the semiannual interest expense and amortization of discount on bonds payable.

December 31

This is the same adjusting entry made on December 31, 20-1 above.

The company also makes additional contribution to its sinking fund; thus, the payment of \$11,000 must be recognized as a debit to the bond sinking fund while crediting a cash account.

Year 20-8:

June 15

Another contribution to sinking fund is made amounting to \$30,000.  Debit bond sinking fund and credit cash to record this contribution.

November 30

The company makes the second interest payment for this year.  Please refer to the calculation in May, Year 20-2 above for the semiannual interest expense and amortization of discount on bonds payable.

The company also calls the bonds at 102%.  Since the current sinking fund balance of \$320,000 as provided in the problem is not enough to pay the bonds, the company makes additional contribution to its sinking fund.  The calculation is as follows:

Debit \$496,000 to bond sinking fund while crediting a cash account.

With a callable rate of 102%, the company incurs a loss of \$23,200 in redeeming the bonds.  To calculate the loss, remaining balance of discount on bonds payable must be calculated first.  Multiply the monthly amortization of \$200 by the number of months from November, Year 20-1 to November, Year 20-8.  Deduct the total amortization from \$24,000 to get the remaining balance of discount on bonds payable.

Deduct the remaining balance of \$7,200 from the face value of the bonds to get the carrying value of the said bonds.  Then, deduct the amount paid to get the loss on bonds redeemed.

The amount paid to bondholders is not provided in the problem but this can be calculated by multiplying the face value of the bonds by the callable rate of 102%.