Question

AP10-5 Recording Bond Issuance, Interest Expense, and Effects of Bond Redemption of Financial Statements (Effective-Interest Method) (P10-7) Ashraf Ltd. sold on June 30, 2017, $4,000,000, 20-year bonds, paying a nominal interest rate of 6.5 percent. The bonds were issued at 105.7344 percent with a yield of 6 percent. The bonds pay annual interest on June 30. The company uses the effective interest method and its fiscal year ends on December 31. Required: 1. Prepare the journal entry to record the issuance of the bond. 2. Show how the liability for bonds payable would be presented on the statement of financial position as at December 31, 2017 3. Prepare the journal entry to record the first interest payment on June 30, 2018. 4 Ashraf Ltd decided on June 30, 2018, to redeem the outstanding bonds at 102 percent naminat interest to bondholders. Show how the effects of this transaction would be the statement of earnings and the statement of cash flows for the year ended June 30, 2018 The companu uses the indirect method to prepare the operating section of the statement of cash 5. Why would Ashraf Ltd. engage in an early redemption of its bonds? Explain.

Answer 1

1. In the books of Ashraf Ltd. :

Date	Account Titles	Debit	Credit
		$	$
June 30, 2017	Cash	4,229,376
	Premium on Bonds Payable		229,376
	Bonds Payable		4,000,000
	To record issuance of bonds payable

2.

Ashraf Ltd. Statement of Financial Position ( Partial ) December 31, 2017
Liabilities
Long Term Liabilities
Bonds Payable
Par Value	4,000,000
Premium on Bonds Payable	226,257.28	4,226,257.28

3.

Date	Account Titles	Debit	Credit
		$	$
June 30, 2018	Interest Expense	126,787.71
	Premium on Bonds Payable	3,212.29
	Interest Payable	130,000
	Cash		260,000
	To record payment on interest on bonds

4.

Date	Account Titles	Debit	Credit
		$	$
June 30, 2018	Bonds Payable	4,000,000
	Premium on Bonds Payable	223,045
	Gain on Redemption of Bonds		143,045
	Cash		4,080,000

Gain on redemption of $ 143,045 would be reported as other income on the statement of earnings, and deducted in the Operating Activities section of the statement of cash flows, while, $ 4,080,000 would be reported as an outflow under the Financing Activities section as cash paid to redeem bonds payable.

5. The market interest rate has decreased further, causing the bond price to fall. It would make financial sense to sell the bonds at a gain.