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On January 1, 2014, Jade Company issued $2,000,000 face value, 7%, 10-year bonds at $2,147,202. This price resulted in a 6% effective-interest rate on the bonds. Jade uses the effective-interest method to amortize bond premium or discount. The bonds pay annual interest on each January 1.

Instructions
(a) Prepare the journal entries to record the following transactions.
(1) The issuance of the bonds on January 1, 2014.
(2) Accrual of interest and amortization of the premium on December 31, 2014.
(3) The payment of interest on January 1, 2015.
(4) Accrual of interest and amortization of the premium on December 31, 2015.
(b) Show the proper long-term liabilities balance sheet presentation for the liability for bonds payable at December 31, 2015.
(c) Provide the answers to the following questions in narrative form.
(1) What amount of interest expense is reported for 2015?
(2) Would the bond interest expense reported in 2015 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used?

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Answer:

(a)

Prepare the journal entries to record the following transactions.

(1) The issuance of the bonds on January 1, 2014.

  • Dr Cash 2,147,202
  •     Cr Bonds payable 2,000,000
  •     Cr Premium on bonds payable 147,202

(2) Accrual of interest and amortization of the premium on December 31, 2014.

effective interest rate amortization = ($2,147,202 x 6%) - ($2,000,000 x 7%) = $128,832.12 - $140,000 = -$11,167.88 ≈ -$11,168

  • Dr Interest expense 128,832
  • Dr Premium on bonds payable 11,168
  •     Cr Interest payable - bonds 140,000

(3) The payment of interest on January 1, 2015.

  • Dr Interest payable - bonds 140,000
  •     Cr Cash 140,000

(4) Accrual of interest and amortization of the premium on December 31, 2015.

effective interest rate amortization = ($2,136,034 x 6%) - ($2,000,000 x 7%) = $128,162 - $140,000 = -$11,838

  • Dr Interest expense 128,162
  • Dr Premium on bonds payable 11,838
  •     Cr Interest payable - bonds 140,000

(b)

Show the proper long-term liabilities balance sheet presentation for the liability for bonds payable at December 31, 2015.

Long term liabilities:

Bonds payable $2,000,000

Premium on bonds payable $124,196

(c)

Provide the answers to the following questions in narrative form.

(1) What amount of interest expense is reported for 2015?

  • During 2015, total interest expense on bonds payable is equal to $128,162.

(2) Would the bond interest expense reported in 2015 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used?

  • If the straight line amortization method was used, the interest expense during 2015 would have been less than the current interest expense using the effective interest method ($125,280 < $128,162).

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