Chapter Outline Notes
VIII. Issuing Bonds Between Interest Dates (Appendix 10C)
A. Procedure used to simplify recordkeeping:
1. Buyers pay the purchase price plus any interest accrued since the
prior interest payment date.
2. This accrued interest is repaid to these buyers on the next
interest date.
3. Entry to record issuance of bonds between interest dates: debit
Cash, credit Interest Payable (for any interest accrued since the
prior interest payment date), credit Bonds Payable.
4. Entry to record first semiannual interest payment for bonds
issued between interest dates: debit Interest Payable (for amount
accrued in entry above), debit Interest Expense (for interest
accrued since issuance date), credit Cash.
B. Accruing Bond Interest Expense
1. Necessary when bond’s interest period does not coincide with
issuer’s accounting period.
2. Adjusting entry is necessary to record bond interest expense
accrued since the most recent interest payment and requires
amortization of the premium or discount for this period.
3. Affects the subsequent interest payment date entry.
IX. Leases and Pensions (Appendix 10D)
a. Lease Liabilities
A lease is a contractual agreement between a lessor (asset owner)
and a lessee (asset renter or tenant) that grants the lessee the right to
use the asset for a period of time in return for cash (rent) payments.
Lease accounting will change over the next few years, whereby
operating leases are likely to be accounted for similar to capital
leases.
1. Operating leases are short-term (or cancelable) leases in which
the lessor retains the risks and rewards of ownership.
a. Lessee records lease payments as expenses.
b. Lessor records lease payments as revenues.
2. Capital leases are long-term (or noncancelable) leases in which
the lessor transfers substantially all risks and rewards of
ownership to the lessee.
a. The lease must meet any one of the four following criteria:
i. Transfer title of leased asset to lessee.
ii. Contain a bargain purchase option.
iii. Have lease term of 75% or more of leased asset’s useful
life.
iv. Have present value of lease payment of 90% or more of
leased asset’s market value.
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Chapter Outline Notes
b. Failure to meet one of the criteria results in off-balance-
sheet financing (not recorded on the balance sheet)
c. Capital leases are recorded as assets and liabilities. The asset
is depreciated. At each lease payment date, the liability is
amortized to record interest expense incurred.
B. Pension Liabilities
A pension plan is a contractual agreement between an employer and
its employees for the employer to provided benefits (payments) to
employees after they have retired.
1. Employer records their payment into pension plan as a debit to
Pension Expense and a credit to Cash.
2. Based on contracted benefits, pension plans can be overfunded
(resulting in plan assets) or underfunded (resulting in plan
liabilities).
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Alternate Demonstration Problem
Chapter 10
Note: Instructor can choose the interest amortization method. Solution
one demonstrates the straight line method and solution two
demonstrates the effective interest method.
ABC Company issued $200,000 face value bonds on January 1, 2015,
with semiannual interest payments to be made on June 30 and December
31 at a contract rate of 10%. The bonds were scheduled to mature five
years after they were issued. On January 1, 2018, three years after the
bonds were issued, the company repurchased 40% of the outstanding
bonds for $79,000.
Required:
Part A
1. Assume that the bonds were issued when the market rate of interest
was 9%. Show calculation of issue price. If using the effective
interest method of amortization, prepare a schedule showing the
bond interest expense and amounts of amortization for the life of the
bonds. If using straight line, show the calculation of the periodic
amortization within the appropriate journal entries explanations.
2. Prepare the journal entry to record the bond issuance.
3. Prepare journal entries for the first two interest payments.
4. Prepare the journal entry to recognize the partial repurchase of the
bonds.
Part B
Redo Part A under the assumption that the market rate on the bonds
when issued was 16%.
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Solution One: Alternate Demonstration Problem
Using Straight Line Interest Method of Amortization
Chapter 10
1. Calculation of cash received upon issuance of bonds (issue price):
Present value of $200,000 to be
received in 10 periods, discounted
at 4.5% per period
$200,000 x .6439 = $128,780
Premium on Bonds Payable……………………. 7,907
3. 6/30/15
Bond Interest Expense…………….….….……..….… 9,309.30
Premium on Bonds Payable…………………..…..… 790.70
Cash………………………………………..…………..… 10,000.00
(7,907 / 10 periods = 790.70 per period)
12/31/15
Cash………………………………………..…………..… 10,000.00
4. 1/1/18
Bonds Payable…………………………………………….. 80,000.00
Premium on Bonds Payable…………………..…..… 1265.12*
Cash………………………………………..…………..… 79,000.00
Redemption Price $79,000 = Gain $2,265.12
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Part B
1. * Calculation of cash received upon issuance of bonds (issue price):
Present value of $200,000 to be
received in 10 periods, discounted
$200,000 x .4632 = $ 92,640
2. 1/1/15
3. 6/30/15
Bond Interest Expense…………….….….……..….… 14,025.90
Discount on Bonds Payable………….….….…. 4,025.90
Cash………………………………………..…………..… 10,000.00
(40,259/10 periods = 4,025.90 per period)
4. 12/31/15
Cash………………………………………..…………..… 10,000.00
1/1/18
Bonds Payable…………………………………………….. 80,000.00
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Solution Two: Alternate Demonstration Problem
Using Effective Interest Method of Amortization
Chapter 10
1.
Period
Beginning
of Period
Carrying
Amount
Interest
Expense
to be
Recorded
Interest
to be Paid
to Bond-
holders
Premium
to be
Amortized
Unamortized
Premium end
of Period
End-of-
Period
Carrying
Amount
0 $7,907 $207,907 *
1 $207,907 $9,356 $10,000 $644 7,263 207,263
2 207,263 9,327 10,000 673 6,590 206,590
3 206,590 9,297 10,000 703 5,887 205,887
4 205,887 9,265 10,000 735 5,152 205,152
10 200,949 9,051 10,000 949 0 200,000
* Calculation of cash received upon issuance of bonds:
Present value of $200,000 to be
received in 10 periods, discounted
at 4.5% per period
$200,000 x .6439 = $128,780
Present value of $10,000 to be
discounted at 4.5% per period
$207,907
2. 1/1/15
Cash………………………………………..………………….. 207,907
Bonds Payable……………………………………..… 200,000
Premium on Bonds Payable……………………. 7,907
Cash………………………………………..…………..… 10,000
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12/31/15
Bond Interest Expense…………….….….……..….… 9,327
Premium on Bonds Payable…………………..…..… 673
Cash………………………………………..…………..… 10,000
4. 1/1/18
Bonds Payable…………………………………………….. 80,000
Part B
1.
Period
Beginning
of-Period
Carrying
Amount
Interest
Expense
to be
Recorded
Interest to
be Paid
to Bond-
holders
Discount
to be
Amortized
Unamortized
Discount end
of Period
End-of-
Period
Carrying
Amount
0 $40,259 $159,741 *
3 165,522 13,242 10,000 3,242 31,236 168,764
4 168,764 13,501 10,000 3,501 27,735 172,265
10 194,447 15,553 10,000 5,553 0 200,000
* Calculation of cash received upon issuance of bonds:
Present value of $200,000 to be
received in 10 periods, discounted
at 8% per period
$200,000 x .4632 = $ 92,640
Present value of $10,000 to be
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2. 1/1/15
Cash………………………………………..………………….. 159,741
Bonds Payable……………………………………..… 200,000
3. 6/30/15
Bond Interest Expense…………….….….……..….… 12,779
Discount on Bonds Payable……………………. 2,779
Cash………………………………………..…………..… 10,000
4. 12/31/15
Cash………………………………………..…………..… 79,000
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