On July 1, 2013, Waubonsee Ltd. issued $3.2 million of 10-year, 6% bonds at $3,449,423. This price resulted in a market interest rate of 5%. The bonds pay semi-annual interest on July 1 and January 1, and Waubonsee has a December 31 year end.
Instructions
(a) Record the following transactions:
1. The issue of the bonds on July 1, 2013
2. The accrual of interest on December 31, 2013
3. The payment of interest on January 1, 2014
4. The payment of interest on July 1, 2014
(b) Answer the following questions:
1. What amount of interest expense is reported for 2013?
2. Would the interest expense reported in 2013 be the same as, greater than, or less than the amount that would be reported if the bonds had been issued at a discount rather than at a premium? Explain.
3. Determine the total cost of borrowing over the life of the bonds.
4. Would the total interest expense be greater than, the same as, or less than the total interest expense that would be reported if the bonds had been issued at a discount rather than at a premium? Explain.
5. Assuming that the bonds were issued at a market interest rate of 7%, calculate the issue price of the bonds. Determine the total cost of borrowing over the life of the bonds.
Taking It Further
Explain what the impact would be on interest expense if the market rate of interest changed to 5.5% in December 2013 aft er the bonds were issued.