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Journal entires for bonds and computing interest on bonds
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I am having a difficult time understanding bonds.
Here is a question that stumps me:
Record the sale of $4 million of 10 year, 6% corporate bonds priced at 104 plus two months accrued interest.
First, "at 104" means at 104% of the face value of the bonds, so that gives you the selling price.
They've unfortunately added the complication of a partial payment period. It would probably be easier if you learned on ones that do not have that extra interest first. So let's pretend for a minute that it doesn't exist. You would debit the cash for the total you figured above, because that's how much they're actually getting. You always credit the Bond Payable for the face value of the bonds, because that is how much they will have to pay back. i.e. they aren't paying back what they got. The difference between the face value and what they actually got for the bonds is a premium or discount, premium if higher and discount if lower. That part is usually not too difficult. You can see from what is entered thus far that there's an amount missing on one side, i.e. it doesn't balance. So you just need to make it balance. Since a premium would add to the bond value, that has to be a credit just like the bonds. And since a discount reduces the bond value, that would have to be the opposite of the bonds, i.e. a debit, because it needs to reduce the credit. Since these sold at 104%, that's obviously a premium cause it's higher.
Now... the added problem of the interest. You need first to figure out the interest per year. Then figure out two months worth of that. This is a little strange. When the interest payment is due, the company is going to pay all of the interest, even though it's in the middle of a payment period. i.e. they'll pay the whole amount, including that two months. But the two months shouldn't be paid because the bonds were sold two months into the payment period. So the investors buying the bonds are going to pay that two months up front to the company. You're going to credit that to the Interest Expense account, which is negative for that account. Later, the entire interest amount will be paid. So the company's sort of "paying back" that prepaid interest. It will be debited to the Interest Expense. That debit will go against the two months of credit, and the balance in the account will NET to the 10 months of interest expense.
I wish I could show it in t accounts cause that would make much more sense. But try this and see what you come up with. We don't actually do homework problems for you, but if you make an attempt, we can check your work, and then give further hints if necessary.
This is what I did, but I though it was too easyQuote:
Originally Posted by morgaine300
Cash 4,200,000
Bond payable (face value) 4,000,000
Premium on bonds payable 160,000
Interest payable 40,000
To record sale of 40,000 bonds plus 2 months accrued interest.
Well, you didn't specify which are the debits and credits (you need to put Dr & Cr in front of everything around here), but assuming the Cash is debit & the rest are credits, it's almost correct. It should be interest expense, not payable. I know it seems like it oughta be a payable, but normally it goes into interest expense. When the year's interest is paid later, the entire 240,000 will be debited to the expense account, which will net the expense to 200,000, which is how much the company actually should be paying for 10 months. (This does not include the possible complication of having to do an adjusting entry at year-end -- the problem didn't go into that.)
Although... your book could conceivably put it into a payable. So you might want to check that.
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