CHAPTER 6 EFFECTIVE INTEREST METHOD Market price of bonds TECHNICAL KNOWLEDGE To understand the effective interest method of amortizing premium and discount on bonds payable. To distinguish effective rate and nominal rate of interest. To know the computation of the market price or issue price of bonds payable. 188Introduction IFRS requires that discount:on bonds payable, premium on bonds payable and bond issue cost shall be amortized using the effective interest method. The effective interest method is also known as scientific method or simply interest method. The effective interest method distinguishes two kinds of interest rate, namely the nominal rate and effective rate. The nominal rate is the coupon or stated rate. The effective rate is the yield or market rate. The effective rate is the rate that exactly discounts estimated cash future payments through the expected life of the bonds payable to the net carrying amount of the bonds payable. When bonds are sold at face amount, the effective rate and the nominal rate are the same. But when the bonds are sold at a discount or premium, the two rates differ. When bonds are sold at a premium, the effective rate is lower than the nominal rate. 2 When the bonds are sold at a discount, the effective rate is higher than the nominal rate. EFFECTIVE INTEREST METHOD Under the effective interest method, the effective interest expense is determined by multiplying the effective rate by the carrying amount of the bonds payable. The carrying amount of the bonds payable changes every year as the amount of premium or discount is amortized periodically. The effective interest is then compared with the nominal interest. The difference is the premium or discount amortization. Premium amortization ‘ Nominal interest (nominal rate x face amount) xx Less: Effective interest (effective rate x carrying amount) xx Premium amortization — Discount amortization Effective interest XX Less: Nominal interest os Discount amortization XxEffective amortization of discount On January 1, 2022, an entity issued two-year 8% bonds payable with face amount of P1,000,000 for P964,540, a price which will yield a 10% effective interest cost per year. Interest is payable semiannually on June 30 and December 31. Schedule of amortization Interest Interest Discount Carrying Date paid expense amortization © amount Jan. 1, 2022 964,540 Jun. 30,2022 40,000 48,227 8,227 972,767 Dec. 31,2022 40,000 48,638 8,638 981,405 Jun. 30,2023 40,000 49,070 9,070 990,475 Dec. 31,2023 40,000 49,525 9,525 1,000,000 Interest paid Face amount times semiannual nominal rate of 4% or P40,000. Interest expense Carrying amount times semiannual effective rate. Thus, for the period January 1 to June 30, 2022, the interest expense is P964,540 times 5% or P48,227. Discount amortization Interest expense minus interest paid. Thus, for the period January 1 to June 30, 2022, the discount amortization is P48,227 minus P40,000 or P8,227. Carrying amount Preceding carrying amount plus the discount amortization. Thus, on June 30, 2022, the carrying amount is P964,540 plus P8,227 or P972,767. The carrying amount is actually the amortized cost contemplated in the standard. 190Journal entries for 2022 Jan. 1 Cash 964,540 Discount on bonds payabl 35,460 Bonds payable 1,000,000 June 30 Interest expense 48,227 Cash 40,000 Discount on bonds payable cizz7 The payment of the semiannual interest and the periodic amortization of the discount are compounded in one entry. The two can be separately recorded. Dec. 31 Interest expense 48,638 Cash 40,000 Discount on bonds payable 8,638 Effective amortization of premium On January 1,- 2022, an entity issued three-year 12% bonds payable with face amount of P1,000,000 for P1,049,740, a price which will yield a 10% effective interest cost per year. The interest is payable annually every December 31. Schedule of amortization Interest Interest | Premium Carrying Date paid expense amortization amount Jan. 1, 2022 1,049,740 Dec. 31, 2022 120,000 104,974 15,026 1,034,714 Dec. 31,2023 120,000 103,471 16,529 1,018,185 Dec. 31,2024 120,000 101,815 18,185 1,000,000 Interest paid — Face amount of P1,000,000 times the annual nominal rate of 12% or P120,000. Interest expense — Carrying amount times the annual effective rate. Thus, for 2022, the interest expense is P1,049,740 times 10% or P104,974. Premium amortization — Interest paid minus interest expense. Thus, for 2022, the premium amortization is P120,000 minus P104,974 or P15,026. Carrying amount — Preceding carrying amount minus the premium amortization. Thus, on December 31, 2022, the carrying amount is P1,049,740 minus P15,026 or P1,034,714. 191Journal entries for 2022 Jan. 1 Cash 1,049,740 Bonds payable 1,000,000 Premium on bonds payable 49,740 Dec. 31 Interest expense 120,000 Cash 7 120,000 31 Premium on bonds payable 15,026 Interest expense 15,026 Note that the annual payment of interest and the premium amortization are not compounded in one entry but recorded separately. Market price or issue price of bond payable The market price or issue price of bonds payable is equal to the present value of the principal bond liability plus the present value of future interest payments using the effective or market rate of interest. In other words, the market price of bonds payable is equal to the sum of the following: a. Present value of bonds payable b. Present value of the total interest payments The present value of the principal bond liability is equal to the face amount of the bonds payable multiplied by the present value of 1 factor at the effective rate for a number of interest periods. The present value of the future interest payments is equal to the periodic nominal interest multiplied by the present value of an ordinary annuity of 1 factor at the effective rate for a number of interest periods. 192Illustration Face amount of bonds payable ee Nominal rate : - Effective rate . ee The bonds are issued on January 1, 2022 and mature in four years on January 1, 2026. The interest is payable annually every December 31. Since the interest is payable annually, there are 4 interest periods. The relevant present value factors are: PV of 1 at 8% for 4 periods -7350 PV of an ordinary annuity of 1 at 8% for 4 periods 3.3121 Present value of the bonds payable Present value of principal (4,000,000 x .7350) 2,940,000 Present value of annual interest payments (240,000 x 3.3121) 794,904 Total present value of bonds payable 3,734,904 The annual interest payment of P240,000 is determined by multiplying the face amount of P4,000,000 by the nominal rate of 6%, Face amount of bonds payable 4,000,000 Market price or issue price 3,734,904 Discount on bonds payable 265,096 Table of amortization Interest Interest Discount - Carrying Date paid expense amortization amount Jan. 1, 2022 3,734,904 Dec. 31,2022 240,000 298,792 58,792 3,793,696 Dec. 31,2023 240,000 303,496 63,496 3,857,192 Dec. 31, 2024 240,000 308,575 68,575, 3,925,767 Dec. 31, 2025 240,000 314,233 74,233 4,000,000 193Another illustration Face amount of bonds payable 5,000,000 Nominal rate ¥ 12% Effective rate 10% The bonds are issued on January 1, 2022 and mature in three years on January 1, 2025. The interest is payable semiannually every June 30 December 31. Since the interest is payable semiannually, there are 6 interest periods. The present value factors using the semiannual effective rate are: PV of 1 at 5% for 6 periods _ PV of an ordinary annuity of 1 at 5% for 6 periods 5.0757 Present value of bonds payable Présent value of principal (5,000,000 x .7462) 3,731,000 Present value of interest payments (300,000 x 5.0757) 1,522,710 Total present value of bonds payable The semiannual interest payment of P300,000 is computed by multipying the face amount of P5,000,000 by the semiannual nominal rate of 6%. Market price or issue price of bonds payable 5,253,710 Face amount ‘ 5,000,000 Premium on bonds payable 253,710 Table of amortization Interest Interest Discount Carrying Date paid expense amortization amount Jan. 1, 2022 5,253,710 June 30, 2022 300,000 262,686 37,314 45,216,396 Dec. 31, 2022 300,000 260,820 39,180 5,177,216 June 30, 2023 300,000 258,861 41,139 5,136,077 Dec. 31, 2023 300,000 256,804 43,196 5,092,881 June 30, 2024 300,000 254,644 45,356 5,047,525 Dec. 31, 2024 300,000 252,475 47,525 5,000,000 194PV factor through ordinary calculator The PV of 1 at 5% for 6 periods and the PV of an ordinary annuity of 1 at 5% for 6 periods can be determined through the use of an ordinary calculator. Kindly get your calculator and try the following steps: 1, Enter 1.05 : 2. Press the division sign (+) twice. 3. Press the equal sign (=) for the number of interest periods required. Press once for one period, press twice for two periods and so on. In this case, press 6 times because there are 6 interest périods. 4. The result is the PV of 1 at 5% for 6 periods or .7462. 5. Deduct 1.00 from the result in No. 4. The result is .2538 negative. 6. Press the plus/minus sign (+/-) to remove the negative sign in No. 5. 7. Divide the result in No. 6 by .05. & The result is the PV of an ordinary annuity of 1 at 5% for 6 periods or 5.0757. 195Illustration — Serial bonds Face amount of bonds payable eee Nominal rate : aa Effective rate na Date of issue eae Annual payment every December 31 peed Interest is payable annually December Bl Present value of 1 at 10% One period 0.9091 ‘Twoperiods 0.8264 ‘Three periods 0.7513 - Present value of the bonds payable (a) b) (axb) Principal Interest Total PV Present Date Payment payment payment factor value 12/31/2022 1,000,000 360,000 ~—1,360,000 \ .9091 1,236,376 12/31/2023 1,000,000 240,000 1,240,000 8264 1,024,736 12/31/2024 1,000,000 120,000 ‘1,120,000 7513 _ 841,456 Total present value of bonds payable 3,102,568, Face amount 000,000 Premium on bonds payable 102,568 Interest payment December 31, 2022 (3,000,000 x 12%) 360,000 December 31, 2023 (2,000,000 x 12%) 240,000 December 31,2024 (1,000,000 x 12%) 120,000 Table of amortization Interest’ Interest Premium Principal Carrying Date paid expense’ amortization payment amount 1/1/2022 3,102,568 12/31/2022 360,000 310,257 49,743 1,000,000 2,052,825 12/31/2023 240,000 205,282 34,718 1,000,000 1,018,107 12/31/2024 120,000 101,893 18,107 1,000,000 a 196December 81, 2022 Interest paid (3,000,000 x 12%) Interest expense (3,102,568 x 10%) Premium amortization for 2022 Carrying amount —January 1, 2022 Premium amortization for 2022 Principal payment on December 31, 2022 Carrying amount —- December 31, 2022 December 31, 2023 Interest paid (2,000,000 x 12%) Interestexpense —_(2052'825 x 10%) Premium amortization for 2023 Carrying amount — December 31, 2022 Premium amortization for 2023 Principal payment on December 31, 2023 Carrying amount ~ December 81, 2023 December 31, 2024 Interest paid (1,000,000 x 12%) Interest expense Premium amortization for 2024 360,000 310,257 49,743 3,102,568 (" 49,743) (1,000,000) 2,052,825. 240,000 2,052,825 (34,718) (1,000,000) 018,107 120,000 101,893* 18,107 * 10% x P1,018,107 equals P101,811. There isa difference of P82 due to rounding of present value factors. Journal entries for 2022 1. Issuance of bonds payable: Cash Bonds payable Premium on bonds payable 2. Payment of interest: Interest expense Cash 3. Amortization of premium on bonds payable: Premium on bonds payable Interest expense 4. Payment of principal: Bonds payable Cash 197 3,000,000 102,568 360,000 49,743 1,000,000Effective interest method - bond issue cost IFRS provides that transaction costs that are directly attributable to the issue of a financial liability shall be included in the initial measurement of the financial liability, Transaction costs are defined as fees and commissions paid to agents, advisers, brokers and dealers, levies by regulatory agencies and securities exchange, and transfer taxes and duties. Clearly, transaction costs include bond issue costs, The calculation of effective interest rate shall include all transaction costs, premiums and discounts. Thus, bond issue costs will increase discount on bonds payable and will decrease premium on bonds payable. Under the effective interest method, bond issue cost must be "lumped" with the discount on bonds payable and “netted” against the premium on bonds payable. Illustration — Discount and bond issue cost At the beginning of current year, an entity issued three-year bonds payable with face amount of P10,000,000 and 9% stated rate payable annually every December 31. The bonds are issued at P9,751,210 with an effective yield of 10% before considering the bond issue cost. The entity paid bond issue cost of P239,880. Face amount 10,000,000 Discount on bonds payable (248,790) Issue price 9,751,210 “Bond issue cost (239,880) Net proceeds 9,511,330 198Determination of new effective rate The original effective rate is 10% but because of the bond issue cost, the new effective rate must be higher than 10%, Thus, the problem is to find an effective rate that will equate the present value of the cash outflows for the bonds payable to the net proceeds of P9,511,330. The cash outflows for the bonds payable include the principal of P10,000,000 and the annual interest payment of P900,000 for 3 years, The effective rate cannot be computed algebraically but by means of trial and error or the interpolation process. The calculation of the effective rate requires the use of mathematical table of present value of a single payment and present value of an ordinary annuity. Again, the original effective rate is 10% but because of the bond issue cost the new effective rate must be higher than 10%. By interpolation and using an effective rate of 11%, the present value of 1 for three periods is .7312. The present value of an ordinary annuity of 1 for three periods at 11% is 2.4437. The present value of the bonds payable using an interest rate of 11% is determined as: PV of principal (10,000,000 x .7312) 7,312,000 PV of interest payments (900,000 x 2.4437) 2,199,330 Total present value 9,511,330 Coincidentally, the present value of the bonds payable of P9,511,330 is the same as the net proceeds of P9,511,330. In conclusion, the new effective rate is 11%. 199Journal entries for current year 1, To record the issuance of the bonds payable: Gash 9,511,330 ‘iscount on bonds payable 488,670 Bondspayable FOOD, Under the effective interest method, the bond issue cost is _ added to the discount on bonds payable. 2. To record the annual interest payment: Interest expense (10,000,000 x 9%) 900,000 a 900,000 3. To record the amortization of the discount on bonds payable using the effective interest method: Interest expense 146,246 Discount on bonds payable 146,246 Interest expense (9,511,330 x 11%) 1,046,246 Interest paid (20,000,000 x 9%) 900,000 Amortization of discount on bonds payable 146,246 Financial calculator Actually, the effective rate can easily be determined through the use ofa financial calculator. In practice, this is usually the case. 1. Enter negative P10,000,000 (cash outflow for principal), press FV 2. Enter negative P900,000 (cash outflow for interest), press PMT Enter 3 (maturity), press N Enter positive P9,511,330 (net proceeds), press PV Press comp (compute) and i% (effective rate) Press EXE (execute) The financial calculator will yield an answer of 11% DES Om oo 200Another illustration — Discount.and bond issue cost At the beginning of current year, an entity issued 5-year bonds payable with face amount of P10,000,000 at 95. The entity paid bond issue cost of P200,000. The nominal rate is 10% and the interest is payable annually on December 81. Face amount 10,000,000 Discount on bonds payable (500,000) Issue price (10,000,000 x 95%) ~ 9,500,000 Bond issue cost (200,000) Net proceeds 9,300,000 Again, the problem is to find an effective rate applicable to the net proceeds of P9,300,000. Since the bonds are issued at a discount, the effective rate must be higher than the nominal rate of 10%. By interpolation, using a rate of 11%, the present value of 1 for 5 periods is 5935. : The present value of an ordinary annuity of 1 for 5 periods at 11% is 3.6959. PV of principal (10,000,000 x .5935) : 5,935,000 PV of interest payments (1,000,000 x 8.6959) 3,695,900 Total present value of bonds payable 9,630,900 The net proceeds of P9,300,000 are lower than the present value of the bonds payable of P9,630,900 using 11% interest rate. This means that the effective rate must be higher than 11%. So another interpolation is made using another rate of 12%. The present value of 1 for 5 periods at 12% is .5674. The present value of an ordinary annuity of 1 for 5 periods at 12% is 3.6048. PV of principal (10,000,000 x .5674) PV of interest payments (1,000,000 x 3.6048) Total present value of bonds payable 201i, han the prege, The net proceeds of P9,300,000 are higher t Present value of the bonds payable of P9,278,800 using a interest rate. This means that the effective rate must be lower thay 12%. 9 In conclusion, the effective rate must be between 11% ang 12%. With this scenario, the differential between 11% Li 12% ig interpolated. Let X as the unknown effective rate. xX -11% 12% -11% The present values applicable to the rates are then substituted. 9,300,000 — 9,630,900 9,278,800 — 9,630,900 330,900 = .94 352,100 This differential of .94 between 11% and 12% is added to 11% to get an effective rate of 11.94%. Financial calculator 1. Enter negative P10,000,000 (cash outflow for principal), press FV 2. Enter negative P1,000,000 (cash outflow for interest), press PMT Enter 5 (maturity), press N Enter positive P9,300,000, press PV Press comp (compute) and i% (effective rate) Press EXE (Execute) The financial calculator will yield an answer of 11.94% oi Bt feIllustration ~ Premium and bond issue cost At the beginning of current year, an entity issued 5-year bonds Payable with face amount of P1,000,000 at 105. The nominal rate is 10% and the interest is payable annually on December 31. The entity paid bond issue cost of P200,000. Face amount 10,000,000 Premium on bonds payable 500,000 Issue price (20,000,000 x 105%) 10,500,000 Bond issue cost (__ 200,000) Net proceeds 10, 100 Cash 10,300,000 Bonds payable 10,000,000 Premium on bonds payable 300,000 Under the effective interest method, the bond issue cost is "netted" against the premium on bonds payable. Since the bonds are issued at a premium, the effective rate must be lower than 10%. By interpolation, using a rate of 9%, the present value of 1 for 5 periods is .6499 and the present value of an ordinary annuity of 1 is 3.8897, . PV of principal (10,000,000 x .6499) 6,499,000 PV of interest payments (1,000,000 x 3.8897) 3,889,700 Total present value of bonds payable 10,388,700 The net proceeds of P10,300,000 are lower than the present value of the bonds payable of P10,388,700 using a 9% interest rate. This means that the effective rate must be higher than 9%. In conclusion, the effective rate must be between 9% and 10%. 203The differential rate between 9% and 10% is interpolated, Let X as the unknown effective rate. X -9% 10% — 9% Substituting the present values applicable to the corresponding rate: 10,300,000 — 10,388,700 10,000,000 — 10,388,700 88,700 388,700 Thus, the effective rate is 9.23% (9% plus .23). Financial calculator Enter negative P10,000,000 (principal) and press FV. Enter negative P1,000,000 (annual interest) and press PMT. Enter 5 (maturity) and press N. Enter positive P10,300,000 (net proceeds) and press PV. Press comp (compute) and i% (effective rate) Press EXE (execute) The financial calculator will yield an answer of 9.23%. be NEape 204QUESTIONS 1. What method ig required in amortizing discount on bonds payable, premium on bonds payable and bond issue cost? 2. Explain a nominal rate of interest. 3. What is a stated or coupon rate of interest? 4. Explain an effective rate of interest. 5. What is a market or yield rate of interest? 6. Explain the effective interest method of amortization. 7. How is interest expense computed under the effective interest method? 8. Explain the market price of bond payable. 9. What is the treatment of bond issue cost under the effective interest method? 10. Explain briefly the "trial and error" or "interpolation" process in computing the effective rate. 205 Bu Dal (-PROBLEMS Problem 6-1 (IAA) Yellow Company received permission on January 1, 2022 to jssue 12% bonds payable with face amount of P6,000,000 maturing on January 1, 2032. Interest is payable annually on December 31. The bonds are callable at 102 plus accrued interest. On January 1, 2022, the entity issued the bonds payable for 6,737,000 with an effective yield of 10%. The fiscal year of the entity ends December 31. The effective jnterest amortization is used. Required: 1.. Prepare journal entries relating to the bonds payable for 2022. 2. Present the bonds payable on December 31, 2022. Problem 6-2 (IAA) On January 1, 2022, Orange Company was authorized to issue 6% bonds payable with face amount of P5,000,000 maturing on December 31, 2023. Interest is payable semiannually on June 30 and December 31. On January 1, 2022, the entity issued all of the bonds payable for P4,818,500 with an effective rate of 8%. The fiscal year of the entity is the calendar year and the effective interest method of amortization is used. Required: 1. Prepare a table of amortization for the discount on bonds payable. 2. Prepare journal entries for 2022 and 2023. 206Problem 6-3 (AA) On January 1, 2022, Blue Company issued, in a private placement with an investment house, P3,000,000 face amount of three-year, 16% bonds payable. Interest is payable semiannually on June 30 and December 31 of each year. The bonds were issued at a price yielding the entity P2,738,682 which represents an effective interest cost of 20% per year. Required: Prepare journal entries to record the issuance of the bonds payable, the interest expense at the end of the first six months and the last six months of the bond issue, and the retirement of the bonds payable at maturity. Problem 6-4 (PHILCPA Adapted) ' On December 31, 2022, Dome Company issued P4,000,000, 8% serial bonds payable, to be repaid in the amount of P800,000 each year. Interest is payable annually on December 31. The bonds were issued to yield 10% a year. The bond proceeds totaled P3,805,600 based on the present value on December 31, 2022 of five annual payments. Present value Due date Principal Interest 0n 12/31/2022 12/31/2023 800,000 320,000 1,018,000 12/31/2024 800,000 256,000 872,200 12/31/2025 800,000 192,000 745,000 12/31/2026 800,000 128,000 633,800 12/31/2027 800,000 64,000 536,600 3,805,600 Required: 1, Determine the carrying amount of the bonds payable on December 31, 2023. The interest method of amortizing discount on bonds payable is used. p Prepare journal entries for 2023. 207Problem 6-5 (IAA) is On January 1, 2022, Bishop Company Th payable with a face amount of P20,000,000. on December 31, 2031. For bonds payable of similar risk and ™ yield is 12%. Interest is paid semiannual December 31, ed 10% bonds ne bonds mature rity, the market lyon June 30 ang : d the PV of ay The PV of 1 at 6% for 20 periods is 031 and "17, ordinary annuity of 1 at 6% for 20 peril Required: ds payable 0; is n 1. Determine the market price of the bon Pp January 1, 2022. dt 2. Prepare the journal entry to recor ponds payable on January 1, 2022. | ct expense on 3. Prepare the journal entry to reco est method. June 30, 2022 using the effective eee expense on, 4. Prepare the journal entry to record in' interest method, Decenfber 31, 2022 using the effective he issuance of the Problem 6-6 (IAA) ed 12% bon On January 1, 2022, Mania Company, adam payable with face amount of P20,000,000. on December 31, 2031. : , the market For bonds payable of similar risk and maturity, the market yield is 10%. Interest is paid semiannually December 31. «5 0.377 he PV of The PV of 1 at 5% for 20 periods is 0.377 and the PV of an ordinary annuity of 1 for 20 periods is 12. Required: ; is payable o 1. Determine the market price of the bonds pay n January 1, 2022. ee 2. Prepare the journal entry to oe the issuance the bonds payable on January 1, 2022. oo 3. Prepare the journal entry to record interest De on June 30, 2022 using the effective interned Hn - 4. Prepare the journal entry to record interest preenee December 31, 2022 using the effective interes > 208Problem 6-7 (ACP) On January 1, 2022, Surigao Company issued bonds payable with face amount of P4,000,000 and stated interest rate of 12%. The interest is payable semiannually on June 30 and December 31. The bonds ‘mature on every D ber 31 at the rate of ry December P2,000,000 per year for 2 years, The prevailing market rate for the bonds payable is 8%, Present value of 1 at 4% One period 0.9615 Two periods 0.9246 Three periods 0.8990 Four periods 0.8548 Required: 1. Compute the market price of the bonds payable on January 1, 2022. 2 Prepare a table of amortization using the effective interest method. : 3. Prepare journal entries for 2022 and 2023. Problem 6-8 (IAA) On March 1, 2022, White Company issued 10% bonds payable with face amount of P7,000,000 to yield 8%. Interest is payable semiannually on March 1 and September 1. The bonds mature in 10 years. The entity follows the calendar year. PV of 1 at 5% for 20 periods 377 PV of 1 at 4% for 20 periods 456 PV of an ordinary annuity of 1 at 5% for 20 periods 12.462 PV of an ordinary annuity.of 1 at 4% for 20 periods 13.590 Required: 1. Determine the market price of the bonds payable. 2. Prepare an effective interest amortization table for the first two interest periods. 3. Prepare journal entries for 2022 209Problem 6-9 (IAA) On June 1, 2022, Java Company issued 10% bonds payable with face amount of P6,000,000 to yield 12%. Interest is payable annually on June 1 of each year. The bonds mature in 5 years. The entity follows calendar year. PV of 1 at 10% for 5 periods 82 PV of Lat 12% for 5 periods 57 PV of an ordinary annuity of 1 at 10% for 5 periods 3.79 PV ofan ordinary annuity of 1 at 12% for 5 periods 3.60 Required: . 1. Determine the market ‘price of the bonds payable. 2. Prepare an effective interest amortization table for the first two interest periods. 3. Prepare journal entries for 2022 and 2023. Problem 6-10 (IAA) On January 1, 2022, Dumaguete Company issued bonds payable with face amount of P6,000,000 with 8% effective yield. The nominal rate of 6% is payable annually on December 31. The bonds mature on every December 31 each year at the rate of P2,000,000 for three years. Present value of 1 at 8% One period 0.98 Two periods 0.86 Three periods 0.79 Required: 1. Determine the market price or issue price of the bonds payable. 2. Prepare journal entries for 2022. The effective interest method of amortization is used. | 3. Determine the carrying amount of th» bonds payable o December 31, 2022. 210problem 6-11 (IAA) On January 1, 202! 1 isaued 10% bonds payable with fico amount of Po,00b,000. The bonds mature on January 1, 2032. The bonds wore issued for P5,316,000 to yield 12%, resulting in bond discount of P6B4,000 The entity used the eft est method of amortizing discount on bonds payable, Interest iw payable semiannually on June 30 and December 31. For the six months ended June 30, 2022, what amount should be reported as bond interest expense? a. 300,000 b. 318,960 c. 334,200 d. 341,040 , Problem 6-12 (IAA) On July 1, 2022, Tara C issued 4,000 8% bonds payable with P1,000 face amount for 3,504,000. The ponds were issued to yield 10%. The bonds mature on July 1, 2031. Interest is payable semiannually on January 1 and July 1. What amount of discount on bonds payable should be amortized for the six months ended December 31, 2022? a. 30,400 b. 24,800 c. 19,840 d. 15,200 Problem 6-13 (IAA) On January 1, 2022, Sun Company issued 10% bonds payable with face amount of P4,500,000. The bonds mature on Jan uary 1, 2032. The bonds were issued for P3,987,000 to yield 12%, resulting in bond discount of P513,000. The entity used the effective interest method of amortizing bond discount. Interest is payable semiannually on January land July 1. For the six months ended June 30, 2022, what amount should be reported as bond interest expense? a. 225,000 b. 239,220 c. 250,650 d. 255,780Problem 6-14 (AICPA Adapted) 4. 99% bonds payable On January 1, 2022, Ward Company, immature on January }, With face amount of P4,000,000, which r 2082, ‘el Hen penis were issued a PS to yrel in bond discount of P244,000. rtizing discount on The entity used the intorest method of ay ont December 31, bonds payable. Interest is payable annual 1d be reporteg 1. On December 31, 2022, what amount shou as discount on bonds payable? a. 228,400 b. 208,000 . 306,440 - 204,000 . ‘ able 0; 2. What is the carrying amount of bonds pay’ . December 31, 2029? id 10%, resulting a. 3,756,000 b. 4,000,000 ¢. 3,771,600 d. 3,740,400 Problem 6-15 (AICPA Adapted) ig boride payable On January 1, 2022. Wolf Company issued 10% bonds Payabl with face amount of P5,000,000, which mature . 2032. a The bonds were issued for P5,675,000 to yield 8%, resulting in bond premium of P675,000. ean The entity used the interest method of oa been Soe 31 bonds payable. Interest is payable annually on a 1 On December 31, 2022, what amount should be reporte as premium on bonds payable? a. 675,000 b. 629,000 c. 607,500 d. 507.500 \ What is the carrying amount of bonds payable on December 31, 2022? wp a. 5,000,000 b. 5,629,000 c. 4,371,000 d. 5,675,000Problem 6-16 (AICPA Adapted) Webb Company had outstanding 7%, 10-year P5,000,000 face amount bonds payable. tending 7 were originally sold to yield 6% annual interest. The entity usea the effective jnterest method to amortize bond premium. On January 1, 2022, the carrying amount of the outstanding bonds payable was B5,250,000. 1. What amount should be reported as premium on bonds payable on December 31, 2022? a. 225,000 b. 172,500 c. 215,000 d. 52,500 2, What is the carrying amount of bonds payable on December 31, 20299 5,250,000 4,785,000 5,215,000 5,000,000 ae op Problem 6-17 (AICPA. Adapted) On January 1, 2022, West Company issued 9% bonds payable with face amount of P5,000,000 which mature on January 1, 2032. The bonds were issued for P4,695,000 to yield 10%. Interest is payable annually on December 31. The entity used the interest method. 1. What amount should be reported as interest expense for 2022? 450,000 469,500 422,550 500,000 Boop 2. What is the carrying amount of the bonds payable on December 31, 2022? 4,695,000 4,704,750 4,714,500 5,000,000 Boop 213Problem 6-18 (IFRS) bonds -year bon On January 1, 2022, Luyang Company. jasued Additionally, payable with face amount of 5,000,000 ae 98. y the entity paid bond issue cost of P140,000. The nominal rate is 10% and the afte e terest inpayabie considering the bond issue cost is. 12%, The in ‘a the effective annually on December 31. The entity used the interest method. d able on What is the carrying amount of the bonds pay December 31, 2022? a. 4,840,000 b. 4,831,200 c. 4,848,000 d. 5,000,000 Problem 6-19 (AICPA Adapted) ' On January 1, 2022, Carrow Company eee Oe eos payable with face amount of P5,000,000 whic Haeaoog December 31, 2031. The bonds were issued for ne " yield 12%, resulting in bond discount of P570,000. i able The entity used the interest method. Interest is pay semiannually on June 30 and December 31. . fe 1. What amount should be reported as interest expense for 2022? a. 532,548 b. 500,000 ce. 531,600 443,000 as 2. What is the carrying amount of the bonds payable on December 31, 2022? 4,430,000 4,461,600 4,462,548 5,000,000 Boop 214Problem 6-20 (IFRS) On January 1, 2022, Masbate Company issued 5-year bonds payable with face amount of P5,000,000 at 110. The entity paid bond issue cost of P80,000 on same date. The stated interest rate on the bonds is 8% payable annually every December 31. The bonds were issued to yield 6% per annum after considering the bond issue cost. The entity used the effective interest method of amortization. On December 31, 2022, what is the carrying amount of the bonds payable? ‘ a. 5,000,000 b. 5,400,000 c. 5,345,200 d. 5,430,000 Problem 6-21 (IFRS) On January 1, 2022, Bontoe Company issued P5,000,000, 8% serial bonds payable to be repaid in the amount of P1,000,000 each year. Interest is payable annually on December 31. The bonds were issued to yield 10% a year. The bonds were issued for P4,757,000 based on the present value at January 1, 2022 of five annual payments. The entity amortized the discount on bonds payable using the interest. method. On December 31, 2022, what is the carrying amount of the bonds payable? a. 4,832,700 b. 3,832,700 c. 4,805,600 d. 3,805,600 215Problem 6-22 (AICPA Adapted) On January 1, 2022, Arrow Company issued 10% bonds payable with face amount of P5,000,000 that mature’ on December 31, 2026. The bonds were issued for P4,632,000 to yield 12%, resulting in bond discount of P368,000. The entity used the interest method of amortizing bond discount. Interest is payable on June 30 and December 31. For the year ended December 31, 2022, what amount should be reported as bond interest expense? a. 557,515 b. 500,000 ec. 250,000 d. 555,840 Problem 6-23 (IAA) On January 1, 2022, Nixon Company reported 10% bonds payable with carrying amount of P5,700,000. The bonds had a face amount of P6,000,000 and were issued to yield 12%. The interest method of amortization is used. Interest was paid on January 1 and July 1 of each year. On July 1, 2022, the entity retired the bonds payable at 102. The interest payment on July 1, 2022 was made as scheduled. 1. What is the carrying amount of the bonds payable on July 1, 2022? a. 5,700,000 b. 5,742,000 e. 6,000,000 d. 5,658,000 2. What amount should be recorded as loss on the early extinguishent of the bonds payable? a. 120,000 b. 378,000 c. 336,000 d. 462,000 216Problem 6-24 (IAA) On January 1, 2022, Moon Company reported 9% bonds payable of P4,000,000 less unamortized discount of P320,000. These bonds were issued to yield 10%. The effective interest method is used. Semiannual interest was paid on January 1 and July 1 of each year. On July 1, 2022, the entity retired the bonds payable at 103 before maturity. What amount should be reported as loss on retirement of the bonds payable on July 1, 2022? 436,000 440,000 432,000 . 120,000 Be aTp Problem 6-25 (AICPA Adapted) On January 1, 2022, Angel Company issued 5-year 5,000 bonds payable with face amount of P1,000 per bond for P5,380,000 to yield 10%. Interest of 12% is payable annually every December 31. On June 30, 2023, the entity retired 2,000 bonds at 96 plus accrued interest. The entity used the interest method. 1. What amount should be recognized as gain or loss on retirement of bonds payable on June 30, 2023? a. 193,560 gain b. 193,560 loss ¢. 179,920 gain d. 179,920 loss 2. What is the carrying amount of the remaining bonds payable on December 31, 2023? 3,228,000 3,190,000 3,149,880 3,129,420 poop 217Problem 6-26 (AICPA Adapted) At the beginnin; " Colt Company issued - g of current year, ten-year bonds payable with face amount of P5.000,000 and a stated interest rate of 8% payable annually at every year-end. The bonds were issued to yield 10%. PV of 1 for 10 periods at 10% 0.3855 PV ofan ordinary annuity of 1 for 10 periods at 10% 6.145 What amount should be reported as issue price of the bonds payable? a. 5,000,000 b. 1,927,500 c. 5,614,500 d. 4,385,500 Problem 6-27 (AICPA Adapted) At the beginning of current year, Margaret Company provided the following information in relation to the issuance of bonds payable: : Face amount P5,000,000 Term Ten years Stated interest rate &% Interest payment date Annually on December 81 Yield 9% At 6% At 9% Present value of 1 for 10 periods 0.558 0.422 Future value of 1 for 10 periods 1.791 2.367 Present value of an ordinary annuity of 1 for 10 periods 7.360 6.418 What amount should be reported as issue price of the bonds payable? a. 5,000,000 b. 4,318,000 c. 4,035,400 d. 2,110,000 218Problem 6-28 Multiple choice (IAA) 1 ™ = What is the interest rate written on the face of the bond? Coupon rate Nominal rate Stated rate Coupon rate, nominal rate or stated rate Boop What is the rate of interest ‘actually incurred? a. Market rate b. Yield rate c. Effective rate d. Market, yield or effective rate When the effective interest method is used, the periodic amortization would a. Increase if the bonds were issued at a discount. b. Decrease if the bonds were issued at a premium. c. Increase if the bonds were issued at a premium. d. Increase if the bonds were issued at either a discount or a premium. 4.The discount on bond payable is charged to interest expense a. Equally over the life of the bond b. Only in the year the bond is issued c. Using the effective interest methotl d. Only in the year the bond matures . Bond issue cost a. Is included in the measurement of the bonds payable measured at amortized cost. b. Is amortized using the interest method over the life of the bonds payable. Increases effectively the market rate of interest. All of these describe bond issue cost. ao 219es 6. Under the effective interest method of amortization, the interest expense is equal to a. The stated rate of interest multiplied by the face amount of the bonds payable. | b. The market rate of interest multiplied by the face amount of the bonds payable. __ ce c. The stated rate of interest multiplied by the beginning carrying amount of the bonds payable. d. The market rate of interest multiplied by the - beginning carrying amount of the bonds payable. 7. When interest expense for the current year is more than interest paid, the bonds were issued at a. A discount b. A premium c. Face amount d. Cannot be determined 8. When interest expense for the current year is less than interest paid, the bonds were issued at a. A discount b. A premium c. Face amount d. Cannot be determined 9. Bonds usually sell at a. Maturity amount b. Face amount c. Present value d. Statistical expected value 10. Which statement is true about bonds payable? a. The specific provisions of a bond issue are described in a document called bond indenture. b. Periodic interest expense is the stated interest rate times the face amount of bond outstanding. c. Bonds sell for a premium when the market rate of interest exceeds stated rate. d. The initial issue price of bonds payable represents the sum of all future cash outflows. 220Problem 6-29 Multiple choice (IAA) 1. When bonds are sold at a premium and the effective interest method is used, at each subsequent interest payment date, the cash paid is a. Less than the effective interest b. Equal to the effective interest c. Greater than the effective interest d. More than if the bonds had been sold at a discount 2. When bonds are sold at a discount and the effective interest method is used, at each subsequent interest payment date, the cash paid is More than the effective interest Less than the effective interest Equal to the effective interest 5 More than if the bonds had been sold at a premium peop 2 . When bonds are sold at a discount and the effective interest method is used, at each interest payment date, the interest expense Increases Decreases Remains the same Is equal to the change in carrying amount Bo op 4. When bonds are sold at a premium and the effective interest method is used, at each interest payment date, the interest expense a. Remains constant b. Is equal to the change in darrying amount c. Increases d. Decreases 5. The effective interest expense is a. The effective rate times the carrying amount of the bond payable at the beginning of interest period. The stated rate times the face amount of the bond. The effective rate times the face amount of the bond. The stated interest rate times the carrying amount of the bond payable at the beginning of interest period.. aos 221‘Problem 6-30 Multiple choice (AICPA Adapted) 1. What is the effective interest rate of a bond measured at amortized cost? a. b. The stated rate of the bond. - The interest rate currently charged by the entity oy by others for similar bond. ' The interest.rate that exactly discounts estimated future cash payments through the expected life of the bond to the net carrying amount of the bond. . The basic risk-free interest rate that is derived from observable government bond prices. 2. For a bond issue which sells for less than face amount, the market rate of interest is Be op Dependent on rate stated on the bond Equal to rate stated on the bond Less than rate stated on the bond Higher than rate stated on the bond 3. What is the market rate of interest for a bond issue which sells for more than face amount? Bo of Less than rate-stated on the bond Equal to rate stated on the bond Higher than rate stated on the bond Independent of rate stated on the bond 4. If bonds are issued at a premium, this indicates that BS op The yield rate exceeds the nominal rate The nominal rate exceeds the yield rate The yield and nominal rates coincide No necessary relationship exists between the two rates 2225. Which statomont is true for bonds payable maturing on a single date when the effective interest method of amortizing discount on bonds payable is used? a. Interest exponse as a percentage of the bond carrying amount varies from period to period ; b, Interest expense increases each six-month period c. Interest expense remains constant each six-month period d. Nominal interest rate exceeds effective interest rate 2 . In theory, the proceeds from the issuance of bonds payable shall be equal to a. ‘The face amount of the bonds payable. b. The present value of the principal due at the end of the life of the bonds payable plus the present value of the interest payments made during the life of the bonds payable. c. The face amount,of the bonds payable plus the present value of the interest payments made during the life of the bonds payable. a. The sum of the face amount of the bonds payable and the periodic interest payments. x ‘The market price of bonds payable issued at a discount is the present value of the principal amount at the market rate of interest a. Less the present value of all future interest payments at the market rate of interest. b. Less the present value of all future interest payments at the rate of interest stated on the bonds. c. Plus the present value of all future interest payments at the market rate of interest. d. Plus the present value of all future interest payments at the rate of interest stated on the bonds. 2 Under international accounting standard, the valuation method used for bonds payable is c Historical cost Discounted cash flow valuation at current yield rate Maturity amount Discounted cash flow valuation at yield rate at issuance Be op 2239. How should an entity calculate the net proceeds from issuance of bonds payable? 10. a. b. Discount the bonds payable at the stated rate of interest. Discount the bonds payable at the market rate of interest. Discount the bonds payable at the stated rate of interest and deduct bond issuance cost. Discount the bonds payable at the market rate of interest and deduct bond issuance cost. An entity issued bonds payable with a stated rate of interest that is less than the effective interest rate. The bonds were issued on one of the interest payment dates, What should the entity report on the first interest payment date? a. b. ae An interest expense that is less than the cash payment made to bondholders. An interest expense that is greater than the cash payment made to bondholders. A debit to discount on bond payable A debit to premium on bond payable. 224