On the first day of its fiscal year, Ramsey Company issued $35,000,000 of 10-year, 9% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 11%, resulting in Ramsey Company receiving cash of $30, 817,399. The company uses the interest method.
a. Journalize the entries to record the following:
1. Sale of the bonds.
2. First semiannual interest payment, including amortization of discount. Round to the nearest dollar.
3. Second semiannual interest payment, including amortization of discount. Round to the nearest dollar.
b. compute the amount of the bond interest expense for the first year.
c. Explain why the company was able to issue the bonds for only $30,817,399 rather than for the face amount of $35,000,000.
 

a.

1. Cash ........................................................................................ 30,817,399

Discount on Bonds Payable................................................. 4,182,601

Bonds Payable................................................................ 35,000,000

2. Interest Expense......................................................................... 1,694,957*

Discount on Bonds Payable........................................... 119,957

Cash................................................................................ 1,575,000

*$30,817,399 × 5.5%

3. Interest Expense......................................................................... 1,701,555*

........................................... Discount on Bonds Payable 126,555

................................................................................ Cash 1,575,000

*($30,817,399 + $119,957) × 5.5%

Note: The following data in support of the proceeds of the bond issue stated in the exercise are presented for the instructor's information. Students are not required to make the computations.

Present value of $1 for 20 (semiannual)

periods at 5.5% (semiannual rate)......................... 0.34273

Face amount...................................................................... × $35,000,000 $ 11,995,550

Present value of annuity of $1 for

20 periods at 5.5%................................................. 11.95038

Semiannual interest payment............................................. × $1,575,000 18,821,849

Total present value of bonds payable................................ $30,817,399

b. Annual interest paid.......................................................... $ 3,150,000

Plus discount amortized.................................................... 246,512 *

Interest expense for first year............................................ $ 3,396,512

*$126,555 + $119,957

c. The bonds sell for less than their face amount because the market rate of interest is greater than the contract rate of interest. This is because investors are not willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).