Problem 10-29B Straight-line amortization of a bond discount

Accounting for Long-Term Debt

Problem 10-29B Straight-line amortization of a bond discount

White Co. was formed when it acquired cash from the issue of common stock. The company then issued bonds at a discount on January 1, Year 1. Interest is payable on December 31 with the first payment made December 31, Year 1. On January 2, Year 1, White Co. purchased a piece of land that produced rent revenue annually. The rent is collected on December 31 of each year, beginning December 31, Year 1. At the end of the six-year period (January 1, Year 7), the land was sold at a gain and the bonds were paid off at face value. A summary of the transactions for each year follows:

Year 1

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

Year 2–Year 6
8. Received land rental income.
9. Recognized interest expense, including the straight-line amortization of the discount, and made the cash payment for interest December 31.
10. Prepared December 31 entry to close Rent Revenue.
11. Prepared December 31 entry to close Interest Expense.

Year 7
12. Sold the land at a gain.
13. Retired the 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 of the categories. 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.

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

During Year 1 and Year 2, Kale Co. completed the following transactions relating to its bond issue. The company’s fiscal year ends on December 31.

Year 1
Mar. 1 Issued $200,000 of eight-year, 6 percent bonds for $194,000. The semiannual cash payment for interest is due on March 1 and September 1, beginning September Year 1.
Sept. 1 Recognized interest expense, including the straight-line amortization of the discount, and made the semiannual cash payment for interest.
Dec. 31 Recognized accrued interest expense, including the straight-line amortization of the discount.
Dec. 31 Closed the interest expense account.

Year 2
Mar. 1 Recognized interest expense, including the straight-line amortization of the discount, and made the semiannual cash payment for interest.
Sept. 1 Recognized interest expense, including the straight-line amortization of the discount, and made the semiannual cash payment for interest.
Dec. 31 Recognized accrued interest expense, including the amortization of the discount.
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 the bonds had sold at face value, what amount of cash would Kale Co. 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 Kale would report on the income statements for Year 1 and Year 2.
e. Determine the amount of interest Kale would pay to the bondholders in Year 1 and Year 2.

Problem 10-31B Straight-line amortization of a bond premium

Whitten Company was started when it issued bonds with $300,000 face value on January 1, Year 1. The bonds were issued for cash at 103. Whitten uses the straight-line method of amortization. They had a 15-year term to maturity and a 6 percent annual interest rate. Interest was payable annually. Whitten immediately purchased land with the proceeds (cash received) from the bond issue. Whitten leased the land for $36,000 cash per year. On January 1, Year 4, the company sold the land for $310,000 cash. Immediately after the sale, Whitten repurchased its bonds (repaid the bond liability) at 104. Assume that no other accounting events occurred in Year 4.

Required
Prepare an income statement, statement of changes in equity, balance sheet, and statement of cash flows for each of 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.)