Appendix 2 EX 14-24 Amortize premium by interest method

Shunda Corporation wholesales parts to appliance manufacturers. On January 1, 2014, Shunda Corporation issued $22,000,000 of five-year, 9% bonds at a market (effective) interest rate of 7%, receiving cash of $23,829,684. Interest is payable semiannually. Shunda Corporation’s fiscal year begins on January 1. The company uses the interest method.

a. Journalize the entries to record the following:

1. Sale of the bonds.

2. First semiannual interest payment, including amortization of premium. Round to the nearest dollar.

3. Second semiannual interest payment, including amortization of premium. Round to the nearest dollar.

b. Determine the bond interest expense for the first year.

c. Explain why the company was able to issue the bonds for $23,829,684 rather than for the face amount of $22,000,000.


Answer:

a. 1. Cash 23,829,684
Premium on Bonds Payable 1,829,684
Bonds Payable 22,000,000
2.
 Interest Expense* 834,039
Premium on Bonds Payable 155,961
Cash** 990,000
* $23,829,684 × 3.5%
** $22,000,000 × 4.5%
3.
 Interest Expense* 828,580
Premium on Bonds Payable 161,420
Cash 990,000
* ($23,829,684 – $155,961) × 3.5%


b. Annual interest paid……………………………………… $1,980,000
Less premium amortized*……………………………… 317,381
Interest expense for first year………………………… $1,662,619
* $155,961 + $161,420

c. The bonds sell for more than their face amount because the market rate of
interest is less than the contract rate of interest. Investors are willing to pay
more for bonds that pay a higher rate of interest (contract rate) than the rate
they could earn on similar bonds (market rate).