On July 1, 2007, Iaket Equipment Inc. issued $12,500,000 of 10-year, 11% bonds at an effective
interest rate of 12%. Interest on the bonds is payable semiannually on December 31 and June 30. The
fiscal year of the company is the calendar year. 1. Journalize the entry to record the amount of the cash
proceeds from the sale of the bonds. 2. Journalize the entries to record the following a. The first
semiannual interest payment on December 31, 200, and the amortization of the bond discount, using
the straight line method. (Round to the nearest dollar). b. The interest payment on June 30, 2008, and
the amortization of the bond discount, using the straight line method. (Round to the nearest dollar). 3.
Determine the total interest expense for 2007 4. Will the bond proceeds always be less than the face
amount of the bonds when the contract rate is less than the market rate of interest? Explain
If Straight Line Method is followed for Bond amortizarion
Part 1
July 1, 2007 (to record the issuance of the bonds)
Cash A/c …............................................Dr. $11,783,130
Discount on Bond Payable ....................Dr. $716,870
Bond Payable..............................................Cr. $12,500,000
Part 2
Dec 31, 2007 (to pay interest and to amortize the Bond Discount)
Interest Expense …...................................Dr. 723,343
Discount on Bond Payable ........................Cr. 35843
Cash A/c........................................................Cr. 687,500
June 30, 2008(to pay interest and to amortize the Bond Discount)
Interest Expense …...................................Dr. 723,344
Discount on Bond Payable ........................Cr. 35844
Cash A/c........................................................Cr. 687,500
Part 3
Total interest expense for 2007 = $ 723,343 (Cash Payment + Amortizarion)
Part 4
Bond proceeds always be less than the face amount of the bonds when the contract rate is less than the
market rate of interest because value of bond proceed is equal to the present value (at current market
rate) of future outflow interest payment and final maturity payment So if the future outflow for a
company are discouted at higher rate of interest than contract rate then the PV would be less and total
bond proceed would be less than the face value.
Also think from investor prespective value of bond equals to the present value of future inflow (interest
payment and final maturity). If an investor is getting higher return in the market then the bond contract
rate then investor would be willing to invest in Bond only if they are issued at discount.