Answers
1)
In straight line method, any discount allowed for issuance of bonds will be amortized in equal installments in every interest period.
| Date | Payment of interest (a) ($) | Amortized discount (b) $ | Interest expense (c) $ | Book value(d) $ |
| ($1000000x13.5%)/2 | ($14,928.32) / 8 | (a+b) | (b+d) | |
| 01/10/2016 | 985071.68 | |||
| 31/03/2017 | 67500 | 1866.04 | 69366.04 | 986937.75 |
| 30/09/2017 | 67500 | 1866.04 | 69366.04 | 988803.76 |
| 31/03/2018 | 67500 | 1866.04 | 69366.04 | 990669.80 |
| 30/09/2018 | 67500 | 1866.04 | 69366.04 | 992535.84 |
| 31/03/2019 | 67500 | 1866.04 | 69366.04 | 994401.88 |
| 30/09/2019 | 67500 | 1866.04 | 69366.04 | 996267.92 |
| 31/03/2020 | 67500 | 1866.04 | 69366.04 | 998133.96 |
| 30/09/2020 | 67500 | 1866.04 | 69366.04 | 1000000 |
2)
Bond interest exp and amortizaton schedule under effective interest method
| Date | Effective interest (a) $ | Actual Interest (b) $ | Discount amortized (c) $ | Book Value (d) $ |
| (d x 14%)/2 | ($1000000x13.5%)/2 | (a-b) | (a+d) | |
| 01/10/2016 | 985071.68 | |||
| 31/03/2017 | 68955.02 | 67500 | 1455.02 | 986526.70 |
| 30/09/2017 | 69056.87 | 67500 | 1556.87 | 988083.57 |
| 31/03/2018 | 69165.85 | 67500 | 1665.85 | 989749.42 |
| 30/09/2018 | 69282.46 | 67500 | 1782.46 | 991531.88 |
| 31/03/2019 | 69407.23 | 67500 | 1907.23 | 993439.11 |
| 30/09/2019 | 69540.74 | 67500 | 2040.74 | 995479.84 |
| 31/03/2020 | 69683.59 | 67500 | 2183.59 | 997663.43 |
| 30/09/2020 | 69836.44 | 67500 | 2336.57 | 1000000.00 |
3)
a)
Adjusting entries for the end of the fiscal year December 31,2016 under straight line method of Amortization
| Date | Particulars | Debit ($) | Credit($) |
| December 31 | Interest Expense Dr ($33750+933.02) To Discount on bonds ($1866.04x3)/6 To Interest payable ($67500x3)/6 (Being interst payable) | 34683.02 | 933.02 33750 |
b)
Journal entries under Effective Interest method of amortization
| Date | Particulars | Debit ($) | Credit ($) |
| Dec 31 | Interest Expense dr To Discount on bonds To Interst Payable (Being Interest Payable) | 34477.51 | 727.51 33750 |
4)
Interest under Straight line method for the period 01/01/2017 to 31/12/2017
Interest = $69366.04 x 2 = $138732.08
Interst Under Effective interest method for the period 01/01/2017 to 31/12/2017 :
Interest from 01/01/2017 to 31/3/2017 ($68955.02-$34683.02) = $34272
Interest from 01/04/2017 to 30/09/2017 is $69056.87
Interest from 1/10/2017 to 31/12/2017 ($988083.57x14%)x3/12 = $34582.92
Interes for the period is t01/01/2017 to 31/12/2017 =$34272 +$69056.87+$34582.92
=$137911.79
now Net income for 2017 under each alternative
| Particulars | Straight line method ($) | Effective Interest method ($) |
| Operating income | 500000 | 500000 |
| (-) Interest for 2017 | 138732 | 137912 |
| Net income for 2017 | 361268 | 362088 |
| (-) Tax @30% | 108380 | 108626 |
| Income after tax | 252888 | 253462 |
5)
a)
If redemption is betweenInterst payment dates , we have to pass journal entries for interest and discount from date of previous interest payment to the date of redemption.
Journal entries for march 31,2017 to June 30,2017
| Date | Particulars | Debit ($) | Credit ($) |
| june 30 | Interest Expense dr | 34683.02 | |
| To discount on bonds | 933.02 | ||
| To interest Payable ( being Interest Payable) | 33750 |
Calculation of carrying value of bonds :
Book value of bonds on March 31 2017 is $986937.72
discount amortized from march to june is $933.02
Carrying value of bonds on 30/06/2017 = $986937.72+$933.02= $987870.74
Gain / loss from Redemption = Carrying Value - call price without interest
= $987870.74 - $980000 = $7870.74
Journal entries for redemption of bonds
| Date | Particulars | Debit ($) | Credit ($) |
| june 30 2017 | Bonds payable dr | 100000 | |
| Interest payable dr | 33750 | ||
| To gain through redemption of bonds | 7870.74 | ||
| To Discounts on bonds payable | 12129.26 | ||
| To cash/bank ($980000+$33750) (being bond redeemed) | 1013750 |
b) Effective Interest method of amortization
| Date | Particulars | Debit $ | Credit $ |
| june 30 2017 | Interest dr ($986526.70x14%x3)/12 | 34528.43 | |
| To discount on bonds payable ($1866.04x3/6) | 778.43 | ||
| To interest payable $67500x3/6 (Being Interest payable) | 33750 |
Carrying value of bonds = book value of bonds on 31st march 2017 + discount amortized for march 31 to june 30 2017
= $986526.70+$778.43 = $987305.13
Gain/loss from redemption of bonds = $987305.13 - $980000 = $7305.13
Journal Entries
| Date | Particulars | Debit $ | Credit $ |
| June 30 2017 | Bond payable dr | 1000000 | |
| Interest Payable dr | 33750 | ||
| To profit from redemption | 7305.13 | ||
| To discount on bonds payable | 12694.87 | ||
| To cash/bank (being bonds redeemed) | 1013750 |
6)
Time Interest Earned ratio = pretax operating income/interest expense
straight line method : $500000/$138732.08 = $3.60
Effective interest method : $500000/$137911.79=$3.63
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