## Answers

Journal entry

Particulars | Debit | Credit |

1)Cash a/c Dr Discount on bond a/c Dr To Bond payble (Bond issued at discount) | 24879677 2320323 | 27200000 |

Profit and loss ac Dr Interest | 746390 | 746390 |

2)Interest expense a/c Dr To Discount on bond payable To Cash (interest payment of first quarter) | 746390 | 202390 544000 |

Profit and loss ac Dr Interest | 746390 | 746390 |

3)Interest expense a/c Dr To Discount on bond payable To Cash (interest payment of second quarter) | 746390 | 202390 544000 |

Notes:

1.Discount on bond

Bond payble =27200000

Cash received =24879677

Total discount oayble =2320323

2.Calculations for Semi-Annual Period : Stated rate or

the annual nominal interest rate on the bond = 4%

. Since interest is payable semi-annually, periodic

interest rate of the bond = stated rate/2 = 10%/2 = 2%

Amount of interest payable every semi-annual period = 27200000*0.02 = 544000

Market value (or book value) of the bond at the

beginning of the first period = $24879677

Nominal (annual) market interest rate = 6%.

Again, effective market interest rate for the

semi-annual period = 6%/2 = 3%

Amount of interest on the market value of the bond

for the first semi-annual period = 24879677*0.03 = 746390

Here is an interesting fact about the interest on the bond. You are required to pay only $544000 to the bondholder every semi-annual period, but you are allowed to deduct the amount of $746390 as an interest expense in determining the Net Income of the company. The extra amount of interest expense you are allowed to deduct is the amount that is set aside so that it can be used to increase the book value of the bond and reduce the amount of discount. Extra interest deductible on the Income Statement = 746390 − 544000 = 202390

Book value of the bond at the end of the first period = $24879677+202390 = 25082067

.