EX 14-6 Entries for issuing bonds and amortizing discount by straight-line method

On the first day of its fiscal year, Woodard Company issued $12,000,000 of 10-year, 8% bonds to finance its operations of producing and selling home improvement products. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 10%, resulting in Woodard Company receiving cash of $10,504,541.

a. Journalize the entries to record the following:

1. Issuance of the bonds.

2. First semiannual interest payment. (Amortization of discount is to be recorded annually.)

3. Second semiannual interest payment.

4. Amortization of discount at the end of the first year, using the straight-line method. (Round to the nearest dollar.)

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

c. Explain why the company was able to issue the bonds for only $10,504,541 rather than for the face amount of $12,000,000.


Answer:

a. 1.
 Cash 10,504,541
Discount on Bonds Payable 1,495,459
Bonds Payable 12,000,000
2.
 Interest Expense 480,000
Cash 480,000
3.
 Interest Expense 480,000
Cash 480,000
4.
 Interest Expense 149,546
Discount on Bonds Payable 149,546


b. Annual interest paid………………………………………………………………… $ 960,000
Plus discount amortized………………………………………………………… 149,546
Interest expense for first year…………………………………………………… $1,109,546


c. The bonds sell for less than their face amount because the market rate of interest is greater than the contract rate of interest. Investors are not willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).