Problem 10-29A Straight-line amortization of a bond premium

Accounting for Long-Term Debt

Problem 10-29A Straight-line amortization of a bond premium

Pine Land Co. was formed when it acquired cash from the issue of common stock. The company then issued bonds at a premium on January 1, Year 1. Interest is payable annually on December 31 of each year, beginning December 31, Year 1. On January 2, Year 1, Pine Land Co. purchased a piece of land and leased it for an annual rental fee. The rent is received annually on December 31, beginning December 31, Year 1. At the end of the eight-year period (December 31, Year 8), the land was sold at a gain, and the bonds were paid off. A summary of the transactions for each year follows:

Year 1

1. Acquired cash from the issue of common stock.
2. Issued eight-year bonds.
3. Purchased land.
4. Received land rental income.
5. Recognized interest expense including the straight-line amortization of the premium and made the cash payment for interest on December 31.
6. Prepared the December 31 entry to close Rent Revenue.
7. Prepared the December 31 entry to close Interest Expense.

Year 2–Year 7
8. Received land rental income.
9. Recognized interest expense, including the straight-line amortization of the premium, and made the cash payment for interest on December 31.
10. Prepared the December 31 entry to close Rent Revenue.
11. Prepared the December 31 entry to close Interest Expense.

Year 8
12. Sold land at a gain.
13. Retired bonds at face value.

Required

Identify each of these 13 events and transactions as an asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE). Explain how each event affects assets, liabilities, equity, net income, and cash flow by placing a + for increase, − for decrease, or NA for not affected under each category. In the Cash Flow column, indicate whether the item is an operating activity (OA), investing activity (IA), or financing activity (FA). The first event is recorded as an example.
Event No. Types of Event Assets = Liabilities + Common Stock + Retained Earnings Net Income Cash Flow 1 AS + NA + NA NA + FA

Problem 10-30A Straight-line amortization of a bond discount

During Year 1 and Year 2, Agatha Corp. completed the following transactions relating to its bond issue. The corporation’s fiscal year is the calendar year.

Year 1
Jan. 1 Issued $300,000 of 10-year, 6 percent bonds for $294,000. The annual cash payment for interest is due on December 31.
Dec. 31 Recognized interest expense, including the straight-line amortization of the discount, and made the cash payment for interest.
Dec. 31 Closed the interest expense account.

Year 2
Dec. 31 Recognized interest expense, including the straight-line amortization of the discount, and made the cash payment for interest.
Dec. 31 Closed the interest expense account.

Required
a. When the bonds were issued, was the market rate of interest more or less than the stated rate of interest? If Agatha had sold the bonds at their face amount, what amount of cash would Agatha have received?
b. Prepare the general journal entries for these transactions.
c. Prepare the liabilities section of the balance sheet at December 31, Year 1 and Year 2.
d. Determine the amount of interest expense that will be reported on the income statements for Year 1 and Year 2.
e. Determine the amount of interest that will be paid in cash to the bondholders in Year 1 and Year 2.

Problem 10-31A Straight-line amortization of a bond discount

OZ Company was started when it issued bonds with a $500,000 face value on January 1, Year 1. The bonds were issued for cash at 96. OZ uses the straight-line method of amortization. They had a 20-year term to maturity and an 8 percent annual interest rate. Interest was payable on December 31 of each year. OZ Company immediately purchased land with the proceeds (cash received) from the bond issue. OZ leased the land for $60,000 cash per year. On January 1, Year 4, the company sold the land for $500,000 cash. Immediately after the sale of the land, Oz redeemed the bonds at 98. Assume that no other accounting events occurred during Year 4.

Required
Prepare an income statement, statement of changes in equity, balance sheet, and statement of cash flows for the Year 1, Year 2, Year 3, and Year 4 accounting periods. Assume that the company closes its books on December 31 of each year. Prepare the statements using a vertical statements format. (Hint: Record each year’s transactions in T-accounts prior to preparing the financial statements.)