ACCT1511 Study Guide - Quiz Guide: Effective Interest Rate, Book Value, Round-Off Error
Tutorial Questions for Topic 2
Q1: Accounting for bonds
At the very beginning of 2008, Heatseaker Ltd issued 200, $1,000 bonds with a coupon rate
of 7.3 percent which is paid annually in arrears to bond holders. The bonds have a 4 year
maturity. The bonds were very well received by the market, so Heatseaker Ltd received
$1045 for each of the bonds. This suggests an effective interest rate (market rate at time when
the bonds were issued) of about 6 per cent.
(Hint: the interest expense for a period is the market rate multiplied with the carrying amount
of the bonds payable (period’s opening balance). The amortisation of either premium or
discount for the period is the different between the period’s coupon payment and the period’s
interest expense. Any rounding error is adjusted for in the last period)
a) Write down the journal entries to record the bond issue at the very beginning of 2008.
Dr Cash 209,000
Cr Bond Premium 9,000
Cr Bonds Payable 200,000
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b) For the year ending 2008, what will be the journal entry?
Dr Interest Expense 12,540.00
Dr Bond Premium 2,060.00
Cr Cash 14,600.00
*Carrying amount at beginning period: 209,000
* Interest expense: 6%*209,000=12,540.00
* Coupon payment: 7.3%*200,000=14,600.00
*Amortisation of Premium: 14,600.00-12,540.00=2,060.00
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c) For the year ending 2009, what will be the journal entry?
Dr Interest Expense 12,416.40
Dr Bond Premium 2,183.60
Cr Cash 14,600.00
*Carrying amount at beginning period: 206,940
* Interest expense: 6%*206,940=12,416.40
* Coupon payment: 7.3%*200,000=14,600.00
*Amortisation of Premium: 14,600.00-12,416.40=2,183.60
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d) For the year ending 2010, what will be the journal entry?
Dr Interest Expense 12,285.38
Dr Bond Premium 2,314.62
Cr Cash 14,600.00
*Carrying amount at beginning period: 204,756.40
* Interest expense: 6%*204,756.40=12,285.38
* Coupon payment: 7.3%*200,000=14,600.00
*Amortisation of Premium: 14,600.00-12,285.38=2,314.62
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e) For the year ending 2011, what will be the journal entry?
Dr Interest Expense 12,158.22
Dr Bond Premium 2,441.78
Cr Cash 14,600.00
*Carrying amount at beginning period: 202,441.78
* Interest expense: 6%*202,441.78=12,146.51
* Coupon payment: 7.3%*200,000=14,600.00
*Amortisation of Premium: 14,600.00-12,146.51=2453.49
*Decrease amortisation of premium to by 11.71 (to 2,441.78) and increase interest expense
with 11.71 (to 12,158.22). This is due to rounding errors. At this stage, the bond premium
account needs to be equal to zero.
Dr Bond Payable 200,000.00
Cr Cash 200,000.00
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f) Is the periodic interest expense higher or lower than the coupon payment?
Lower.
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g) Over the life of the bond, how much will Heatseaker Ltd pay in coupon payments?
58,400 = 4*200,000*7.3%
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h) Over the life of the bond, how much will Heatseaker Ltd record as interest expense?
49400 = 4*200,000*7.3% - 9,000
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Q2: Mid-Session Supplementary Exam 2011, Semester 2: Question 5 (Adapted)
Dig Hard Pty Ltd. is a mining company and has since 2000 conducted mining operations
across two developing countries that are lacking environmental laws. Dig Hard Pty Ltd.’s
mining operations cause severe contamination at local production sites. Although there is no
readily available published environmental policy, Dig Hard Pty Ltd’s CEO, David Kerr, has
in an interview stated that “[Dig Hard] always considers the environment”.
After significant pressure from Environment groups, one of the countries in which Dig Hard
Pty Ltd. has operations passed a new environmental act on the 1 March 2008 that requires
Dig Hard Pty Ltd. to clean its mining sites when it is finished mining. Expert advice obtained
by Dig Hard Pty Ltd. estimate that the fair value of costs to clean up its mining sites when
production is finished is $3,400,000, where 47% is related to the mining operations in the
country that has not yet passed any environmental laws.
a) As of 30 June 2007, did Dig Hard Pty Ltd.’s have a present obligation (justify your
answer) and if yes, what would be the amount of that obligation (1 mark):
No. There is no present obligation. No legal obligation exists. No constructive obligation
exists: the statement by CEO is not enough to create valid expectations (or similar words).
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b) As of 30 June 2008, did Dig Hard Pty Ltd.’s have a present obligation (justify your
answer) and if yes, what would be the amount of that obligation (1 mark):
Yes, legal obligation exists in the country that passed the new environmental act.
Obligation would be: 1,802,000 (3,400,000*53%)
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Document Summary
At the very beginning of 2008, heatseaker ltd issued 200, ,000 bonds with a coupon rate of 7. 3 percent which is paid annually in arrears to bond holders. The bonds were very well received by the market, so heatseaker ltd received. The amortisation of either premium or discount for the period is the different between the period"s coupon payment and the period"s interest expense. Any rounding error is adjusted for in the last period: write down the journal entries to record the bond issue at the very beginning of 2008. *decrease amortisation of premium to by 11. 71 (to 2,441. 78) and increase interest expense with 11. 71 (to 12,158. 22). At this stage, the bond premium account needs to be equal to zero. Q2: mid-session supplementary exam 2011, semester 2: question 5 (adapted) Dig hard pty ltd. is a mining company and has since 2000 conducted mining operations across two developing countries that are lacking environmental laws.
