Questions: Question 2 (18 points) Ellis Company issues 8.0%, five-year bonds dated January 1, 2021, with a 530,000 par value. The bonds pay interest on June 30 and December 31 and are issued at a price of 540,871. The annual market rate is 7.5% on the issue date. Required: 1. Compute the total bond interest expense over the bonds' life. (6 points) 2. Prepare an effective interest amortization table for the first year of bonds' life. (6 points) 3. Prepare the journal entries to record the first two interest payments. (6 points)

Solution Steps

1. Compute the total bond interest expense over the bonds' life:

   • Calculate the semi-annual interest payments.
   • Determine the total interest paid over the life of the bond.
   • Calculate the total bond interest expense by adding the total interest paid and the discount/premium amortized.

2. Prepare an effective interest amortization table for the first year of bonds' life:

   • Calculate the effective interest for each period using the market rate.
   • Determine the amortization of the bond premium for each period.
   • Update the carrying amount of the bond after each period.

3. Prepare the journal entries to record the first two interest payments:

   • Record the interest expense and the amortization of the bond premium for each period.
   • Record the cash interest payment.

To compute the total bond interest expense over the bonds' life, we first calculate the semi-annual coupon payment:

\[ \text{Semi-annual coupon payment} = \frac{8\%}{2} \times 530,000 = 21,200 \]

Next, we find the total interest paid over the life of the bond:

\[ \text{Total interest paid} = 21,200 \times 10 = 212,000 \]

Finally, we calculate the total bond interest expense by adding the total interest paid and the premium amortized:

\[ \text{Total bond interest expense} = 212,000 + (540,871 - 530,000) = 222,871 \]

We prepare the effective interest amortization table for the first year. The carrying amount starts at the issue price of \( 540,871 \).

For each period, we calculate the interest expense and the amortization of the premium:

• Period 1: \[ \text{Interest expense} = 540,871 \times \frac{7.5\%}{2} = 20,282.6625 \] \[ \text{Amortization} = 21,200 - 20,282.6625 = 917.3375 \] \[ \text{New carrying amount} = 540,871 - 917.3375 = 539,953.6625 \]

• Period 2: \[ \text{Interest expense} = 539,953.6625 \times \frac{7.5\%}{2} = 20,248.2623 \] \[ \text{Amortization} = 21,200 - 20,248.2623 = 951.7377 \] \[ \text{New carrying amount} = 539,953.6625 - 951.7377 = 539,001.9248 \]

The amortization table for the first year is as follows:

• Period 1: \( (1, 20,282.6625, 917.3375, 539,953.6625) \)
• Period 2: \( (2, 20,248.2623, 951.7377, 539,001.9248) \)

The journal entries for the first two interest payments are as follows:

• Period 1:

  • Debit Interest Expense: \( 20,282.6625 \)
  • Credit Cash: \( 21,200 \)
  • Credit Premium Amortization: \( 917.3375 \)

• Period 2:

  • Debit Interest Expense: \( 20,248.2623 \)
  • Credit Cash: \( 21,200 \)
  • Credit Premium Amortization: \( 951.7377 \)

Final Answer