a. Issuance of bonds on May 1, 2014.
b. First interest payment on November 1, 2014, and amortization of bond premium for six months, using the straight-line method. (Round to the nearest dollar.)
c. Explain why the company was able to issue the bonds for $22,842,560 rather than for the face amount of $20,000,000.
Answer:
a. Cash 22,842,560
Premium on Bonds Payable 2,842,560
Bonds Payable 20,000,000
b. Interest Expense 757,872
Premium on Bonds Payable* 142,128
Cash** 900,000
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).
* $2,842,560 ÷ 20 semiannual payments
** $20,000,000 × 9% × 6/12
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).