Titania Co. sells $400,000 of 12% bonds on June 1, 2012. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2016. The bonds yield 10%. On October 1, 2013, Titania...

Titania Co. sells $400,000 of 12% bonds on June 1, 2010. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2014. The bonds yields 10%. On October 1, 2011, Titania buys back $120,000 worth of the bonds for $126,000 (inc
Titania Co. sells $400,000 of 12% bonds on June 1, 2010. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2014. The bonds yields 10%. On October 1, 2011, Titania buys back $120,000 worth of the bonds for $126,000 (includes accrued interest). Give the entries through December 31, 2012.
Solution:-
Note: Solutions provided for both straight line method and effective interest rate method.
1st Straight line method
If the coupon rate on a coupon issue exceeds the prevailing market interest rate for comparable bonds, the bonds will sell at an amount above their face value.
We can find how much Titania sells the bond by using the following formula.
Where as
B is the issued price/cu
ent price
C is the coupon payment
is the cu
ent interest rate
onds yield
n is the period
C = ($400,000 x 0.12)/2 = $24,000
n = 4 years x 2 = 8
= 0.10/2 = 0.05
         
B = $24,000 x [1   -     1      ]     +     400,000
                            (1 + 0.05)8            (1 + 0.05)8
                               0.05
B = $425,853
June 1, 2010    Cash                                                    425,853
                                    Bonds payable                                                                        400,000
                                    Premium on bonds payable                                         25,853
           
           
            Amount received at issuance                                                  425,853
            Amount to be repaid at maturity                                            400,000
            Excess of cash received over cash paid (premium)                 ( 25,853)
            Cash interest payments ($48,000 x 4)                                     192,000
                                    Total Interest Cost                                         166,147
The average yearly interest cost over the life of the bond issue is 41,536.75 (166,147/4 years). Also, the premium should be periodically written off or amortized as a reduction of the interest cost over the life of the issue. For Titania, the premium amortization per year would be $6,463.25 (25,853/4 years) or $3,231.63 on each semiannual interest date.
December 1, 2010       Interest Expense                                 20,768.38
                                    Premium on bonds payable                 3,231.63
                                                Cash                                                                24,000.00
June 1, 2011                Interest Expense                                 20,768.38
                                    Premium on bonds payable                 3,231.63
                                               ...