Gabriel Co. produces and distributes semiconductors for use by computer manufacturers. Gabriel Co. issued $600,000...
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Accounting
Gabriel Co. produces and distributes semiconductors for use by computer manufacturers. Gabriel Co. issued $600,000 of 10-year, 8% bonds on May 1 of the current year at face value, with interest payable on May 1 and November 1. The fiscal year of the company is the calendar year.
Journalize the entries to record the following selected transactions for the current year
May
1
Issued the bonds for cash at their face amount.
Nov.
1
Paid the interest on the bonds.
Dec.
31
Recorded accrued interest for two months.
GENERAL JOURNAL
Page
Date
Description
Post ref
Debit
Credit
1
1
2
2
3
3
4
4
5
5
6
6
7
7
8
8
9
9
Discount: Contract Rate < Market Rate
Your bonds pay 10% when the market rate is 12%. Investors will not want to buy your bond if they can earn 12% elsewhere. What can you do to get investors to buy your 10% bond? Answer: lower the price.
You will need to drop the price of your bond so the investors are really getting a 12% return. In other words, you need to drop the price to the present value of the bond using a 12% interest rate. You will need to sell the bond at a discount.
The Company issues $1,000,000 5-year bonds with a contract rate of 10% with semi-annual interest payments when the market rate is 12%. Using Present Value tables we determine that an issue price of $926,395 will effectively make our bonds equal to bonds that pay the market 12%.
The journal entry to record issuing the bond is:
GENERAL JOURNAL
Page
Date
Description
Post
Debit
Credit
1
1
2
2
3
3
Discount on Bonds Payable is a contra account which reduces the bonds payable account on the balance sheet. The normal balance of Discount on Bonds Payable is a debit.
For loaning the company $926,395, over the 5 year period the investor will get:
Principal $1,000,000
Interest Payments 500,000
Total 1,500,000
Investment 926,395
Interest Earned $ 573,605
The Borrowing Company will incur $573,605 of interest expense
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