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Bond Premium With Straight Line Amortization

Bond Premium With Straight Line Amortization

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Published by ClassOf1.com
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Bond Premium with Straight Line Amortization:
Looking for personalized help with your financial accounting assignments? Visit http://classof1.com/homework-help/financial-accounting-homework-help/

Bond Premium with Straight Line Amortization:

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Published by: ClassOf1.com on May 07, 2014
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05/07/2014

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Financial ccounting
 
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 *
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.
Subject: Financial Accounting
 
Bond Premium with Straight Line mortization
 What is bond premium?
 When a corporation makes provisions to issue or sell a bond to its investors, it may predict that the proper interest rate will be 7%. In case, investors agree to accept 7% rate of interest, then the bond will sell for its face value. But in case the market interest rate is less than 7%, the corporation will get more than actual face amount of the bond. The sum received for the bond (apart from the rate of interest) which is more than the
 bond’s face amount is called bond premium.
 
Premium on Bonds Payable with Straight-Line Amortization
Over the bond’s life span, balance in account
premium for bonds payable needs to be minimized to 0. For example, bond premium of $3500 must be reduced to $0 during its 5 year life. By reducing it to $0, the book value of the book will be lessened from $ 103,500 on January 1, 2014 to $100,000 when the bonds mature on December 31, 2018. Reduction of the bond in a precise, systematic manner is known as amortization. The bond premium of $3500 was acquired by the corporation as its interest rate to bondholders will be more than the actual amount demanded by market rates of interest. So, amortization of bond premium will include account interest exp
ense. All accounting periods during the bond’s life need to debit to
premium on b
ond’s
payable and credit to interest expense.
 
 *
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for submitting the same in lieu of their academic submissions for grades.
Subject: Financial Accounting
 
Example of Straight-Line Amortization of Bond Premium on Financial Statements
To explain the
premium on bond’s payable, let’s suppose that in early December
2013, a corporation had made a $100,000 bond with an interest rate of 7% per annum. The bond was dated on January 1, 2014 and matures on December 31, 2018. Its interest payment dates are June 30 and December 31 of every year. So, the corporation would have to make semi-annual interest payments of $3500 every year ($ 100,000*7%*
6/12). Let’s
assume that just before selling the bond on January 1, its interest rates in the market falls to 6%. Instead of changing
the bond’s interest rate to
6%, the corporation issues the bond with 7% interest on January 1, 2014. As the bond  with 7% interest will get sold when interest rate in the market is 6%, the corporation  will acquire more than face value of the bond.  Account premium on Bonds Payable is a liability account. It will be with accounts Bond Payable on balance sheet. So, if bonds happen to be long term liabilities, Bonds Payable as well as Premium on Bonds will be reported as long term liabilities. Book  value is the combination of these two accounts. On January 1, 2014 the book value of this bond is $103,500 ($100,000 credit balance in Bonds Payable + $4,100 credit balance in Premium on Bonds Payable).

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