Quiz 2

PROBLEM NO. 7 – Audit of bonds payable

On January 1, 2014, Thunder Corporation issued 2,000 of its 5-year, P1,000 face value, 11%
bonds dated January 1 at an effective annual interest rate(yield) of 9%. Interest is payable each
December 31. Thunder uses the effective interest method of amortization. On December 31,
2015, the 2,000 bonds were extinguished early through acquisition in the open market by
Thunder for P 1,980,000 plus accrued interest.

Jan 1, 2014 - Issuance

Cash 2,155, 534
Bonds Payable 2,000,000
Bonds Premium 155,534

Dec 31, 2014 – Interest

Interest Expense 220,000
Cash 220,000

Premium on Bonds 26,002

Interest Expense 26,002

Dec 31, 2015 – Amortization of premium until retirement

Premium on Bonds 28,342
Interest Expense 28,342

Bonds Payable 2,000,000

Premium on Bonds 101, 190
Interest Expense 220,000
Cash 2,200,000
Gain on early retirement 121, 190
On July 1, 2014, thunder issued 5,000 of its 6-year, P1,000 face value, 10% convertible bonds at
par. Interest is payable every June 30 and December 31. On the date of issue, the prevailing
market interest rate for similar debt without the conversion option is 12%. On July 1, 2015, an
investor in Thunder’s convertible bonds tendered 1,500 bonds for conversion into 15,000
ordinary shares of Thunder, which had a fair value of P105 and a par value of P1 at the date of
conversion.

July 1, 2014 – Issuance

Cash 4,580,950
Discount on Bonds Payable 419,050
Bonds Payable 5,000,000

Dec 31, 2014 – Interest

Interest Expense 250,000
Cash 250,000

Dec 31, 2014 – Amortization ([4,580,950 x 6%] -250,000)

Interest Expense 24,857
Discount on BP 24,857

July 1, 2015 - Conversion

Bonds Payable 5,000,000
Discount on BP

REQUIRED:
Based on the above and the result of your audit, determine the following:
(Round off present value factors to four decimal places)
1. Issue price of the 2,000 5 year bonds
2. Carrying amount of the 2,000 5 year bonds at December 31, 2014
3. Gain on early retirement of bonds on December 31, 2015
4. Equity component of the 6-year bonds
5. Increase share premium as a result of the conversion of the 1,500 6-year

SOLUTION:

Requirement No. 1

1,299,80
PV of principal (P2,000,000 x 0.6499) 0

PV of interest [(P2,000,000 x .11) x 3.8897] 855,734

 2,155,53
Issue price 4

Requirement No. 2

2,155,53
Carrying amount, 1/1/11 (see no. 1) 4
Less premium amortization for 2011:
Nominal interest (P2,000,000 x .
11) 220,000
Effective interest (P2,155,534 x .
09) 193,998 26,002

Carrying amount, 2,129,53

12/31/11 2

Alternative computation:

1,416,80
PV of principal (P2,000,000 x 0.7084) 0

PV of interest [(P2,000,000 x .11) x 3.2397] 712,734

Carrying amount, 2,129,53

12/31/11 4

Requirement No. 3

Retirement price 1,980,000

Carrying amount,
12/31/12:

2,129,53
Carrying amount, 12/31/11 (see no. 1) 2
Less premium amortization for 2012:
Nominal interest (P2,000,000 x .
11) 220,000
Effective interest (P2,129,532 x .
09) 191,658 28,342 2,101,190

Gain early retirement of bonds 121,190

Alternative computation:

1,544,40
PV of principal (P2,000,000 x 0.7722) 0
 PV of interest [(P2,000,000 x .11) x 2.5313] 556,886

Carrying amount, 2,101,28

12/31/10 6

1,980,00
Retirement price 0

Gain early retirement of bonds 121,286

Requirement No. 4

Total proceeds 5,000,000

Less liability component:

Present value of the principal (P5,000,000 x 2,485,00

0.4970) 0

Present value of the interest [(P5,000,000 x .05 x 2,095,95

8.3838) 0 4,580,950

Equity component 419,050

Requirement No. 5

PV of principal (P1,500,000 x 0.5584) 837,600

PV of interest [(P1,500,000 x .05) x 7.3601] 552,008

1,389,60
Carrying amount, 7/1/12 8

Par value of shares issued (15,000 shares x P1) (15,000 )

1,374,60
Net increase in share premium 8