Question

1. United Alliance Inc. needs funds to acquire new equipment and the company decided to raise the funds through issuing bonds or shares. After considering current market situation and company financial position, United Alliance considers On June 30, 2017, the market interest rate is 7%. United Alliance issued $1,000,000 of 8%, 20-year bonds at 110.625. The bonds pay semi-annual interest on June 30 and December 31. United Alliance Inc. amortizes bonds by the effective-interest method.  

a. Explain the difference between long term liability and equity financing. (10 marks

Record issuance of the bonds on June 30, 2017, the payment of interest at December 31, 2017, and the semi-annual interest payment on June 30, 2018. (20 Marks)

Answer 1

Please find below answer :

Part (a) Difference between long term liability and equity financing:

Ans: To raise capital for business needs, companies usually have two type of financing options: equity financing and debt financing. Most companies used the combination of two.

When financing a company, cost is the measurable cost of obtaining capital. With long term debt this is interest expenses a company pay on its debt. With equity, the cost of capital refers to the claim on earning provided to shareholder for their ownership stake.

Differences

Debt financing involves the borrowing of money where as equity financing involves selling a portion of equity in company.

The main advantage of equity financing is that there is no obligation to repay the money raised through it.

Equity financing places no additional financial burden on the company, however the downside is dilution of owner's stake in company.

The main advantage of debt financing is that business owner does not give up control of the business as they do with equity financing.

Creditors looks favorably upon a relatively low debt to equity ratio, which benefits the company if it needs to access additional debt financing in the future.

Most of the startup's choose equity financing as method to raise capital.

Part B ( Journal Entry)

Journal Entry
Year	Particulars	Debit ($)	Credit ($)
June 30 2017	Enrty to record issuance of bond
	Cash A/C ($1000000@110.625%)	$    1,106,250
	To Premium on bond payable	$        106,250
	(1106250-1000000)
	To Bond payable		$    1,000,000
	(Journal enntry to record the issunace of bond)
	Enrty to record interest payment on using effective interest method			Note 1
Decmber 2017	Interest Expenses A/C	$          38,719		Cash Paid	40000	(1000000*8%*1/2)
	Premium on Bond payable A/C	$            1,281		Interest payment	38719	(1106250*7%*1/2)
	To Cash A/C		$          40,000	Premium on Bond payable amortization	1281	(40000-38719)
	(Journal entry to record interest payment)
	Enrty to record interest payment on using effective interest method			Note 2
"June 2018	Interest Expenses A/C	$          38,674		Cash Paid	40000	(1000000*8%*1/2)
	Premium on Bond payable A/C	$            1,326		Interest payment	38674	((1106250-1281)*7%*1/2))
	To Cash A/C		$          40,000	Premium on Bond payable amortization	1326	(40000-38674)
	(Journal entry to record interest payment)