On the first day of its fiscal year, Ebert Company issued $50,000,000 of 10-year, 7% bonds to finance

On the first day of its fiscal year, Ebert Company issued $50,000,000 of 10-year, 7% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 9%, resulting in Ebert Company receiving cash of $43,495,895. 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 discount. Round to the nearest dollar.

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

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

c. Explain why the company was able to issue the bonds for only $43,495,895 rather than for the face amount of $50,000,000.


Answer:

a. 1. Cash 43,495,895
Discount on Bonds Payable 6,504,105
Bonds Payable 50,000,000
2.
 Interest Expense* 1,957,315
Discount on Bonds Payable 207,315
Cash**
* $43,495,895 × 4.5%
** $50,000,000 × 3.5%


3. Interest Expense* 1,966,644
Discount on Bonds Payable 216,644
Cash 1,750,000
periods at 4.5% semiannual rate……………………………… 0.41464
Face amount of bonds…………………………………………… × $50,000,000
* ($43,495,895 + $207,315) × 4.5%
Note: The following data in support of the proceeds of the bond issue stated in
the exercise are presented for the instructor’s information. Students are not
required to make the computations.
Present value of $1 for 20 semiannual
Present value of annuity of $1
for 20 semiannual periods at 4.5% semiannual rate……… 13.00794
$20,732,000
Semiannual interest payment…………………………………… × $ 1,750,000 * 22,763,895
Total present value (proceeds)………………………………… $43,495,895
* $50,000,000 × 3.5%
b. Annual interest paid……………………………………………… $ 3,500,000
Plus discount amortized*………………………………………… 423,959
Interest expense for first year…………………………………… $ 3,923,959
* $207,315 + $216,644
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).