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Federal Semiconductors issued 11% bonds, dated January 1, with a face amount of $800 million on January 1, 2021. The bonds sold for $739,814,813 and mature on December 31, 2040 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Federal determines interest at the effective rate. Federal elected the option to report these bonds at their fair value. On December 31, 2021, the fair value of the bonds was $730 million as determined by their market value in the over-the-counter market. Assume the fair value of the bonds on December 31, 2022 had risen to $736 million.
Required:
1. Prepare the journal entry to record their issuance by Federal on January 1, 2021.
2. Prepare the journal entry to record interest on June 30, 2021 (at the effective rate).
3. Prepare the journal entry to record interest on December 31, 2021 (at the effective rate).
4. At what amount will Federal report the bonds among its liabilities in the December 31, 2021, balance sheet?

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Answer:

1. Prepare the journal entry to record their issuance by Federal on January 1, 2021.

Date                Account title                                       Debit ($)          Credit ($)

Jan 1, 2021      Cash                                                 739,814,813

                        Discount on bonds payable            60,185,187

                        Bonds payable                                                      800,000,000

                        (To record issue of bonds)

2. Prepare the journal entry to record interest on June 30, 2021 (at the effective rate).

Date                   Account title                                     Debit ($)          Credit ($)

June 30, 2021   Interest expense                            44,388,889  

                          Discount on bonds payable                                 388,889  

                            Cash                                                                     44,000,000

                        (To record payment of semi-annual interest)

3. Prepare the journal entry to record interest on December 31, 2021 (at the effective rate).

Date                   Account title                                     Debit ($)          Credit ($)

Dec 31, 2021   Interest expense                            44,412,222  

                          Discount on bonds payable                                 412,222

                            Cash                                                                     44,000,000

                        (To record payment of semi-annual interest)

4. The amount that Federal will report for the bonds among its liabilities in the December 31, 2021, balance sheet is $740,615,924

Explanation:

1. Discount on bonds payable = $800 million - $739,814,813 = $60,185,187

2. Cash paid = Face value × stated interest × interest time period

= $800,000,000 × 11% × 0.5

= $44,000,000

Interest expense = price of bonds × market interest rate × interest time period

= $739,814,813 × 12% × 0.5

= $44,388,889

Discount on bonds payable = $44,388,889 - $44,000,000 = $388,889

3. Cash paid = Face value × stated interest × interest time period

= $800,000,000 × 11% × 0.5

= $44,000,000

Interest expense = price of bonds × market interest rate × interest time period

= ($739,814,813 + $388,889) × 12% × 0.5

= $ 44,412,222

Discount on bonds payable = $44,412,222 - $44,000,000 = $412,222

4.  Long term liabilities = Bonds payable + Discount on bonds payable June 30 + Discount on bonds payable December 31

=  $739,814,813 + $388,889 + $412,222

= $740,615,924

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