. On January 1, 2010, Drennen, Inc., issued $3 million face amount of 10-year, 14% stated rate bonds when market interest rates were 12%. The bonds pay semiannual interest each June 30 and December 31 and mature on December 31, 2019.

Required:a. Using the present value tables in Chapter 6, calculate the proceeds (issue price) of Drennen, Inc.s, bonds on January 1, 2010, assuming that the bonds were sold to provide a market rate of return to the investor.The semi-annual interest payments on the bonds = Stated Rate * Face amount * Period = 14% * $3,000,000 * 6/12 = $210,000

The term of the bond is 10 years, N = 10 *2 = 20 The semi-annual market interest rate = 12% * 6/12 = 6%The present value of Interest = $210,000 for 20 periods at 6% = $210,000 * 11.4699 = $2,408,679 Add the present value of the maturity amount of = $3,000,000 in 20 periods at 6% = $3,000,000 * 0.3118 = $935,400 The proceeds (issue price) of the bonds = PV of interest + PV of maturity value = $2,408,679 + $935,400 = $3,344,079b. Assume instead that the proceeds were $2,950,000. Use the horizontal model (or write the journal entry) to record the payment of semiannual interest and the related discount amortization on June 30, 2010, assuming that the discount of $50,000 is amortized on a straight-line basis.

The semiannual discount amortization, straight-line basis = $50,000 / 20 periods = $2,500 Balance Sheet Income Statement . Assets = Liabilities + Owners Equity Net income = Revenues - Expenses In the balance sheet on the Assets we will show Cash(210,000)

In the Income statement we will show Expenses asInterest Expense(212,500)

Discount on Bonds Payable2,500

Journal entry:

ParticularsDebitCredit

Interest Expense212,500

Cash210,000

Discount on Bonds Payable2,500

c. If the discount in part b were amortized using the compound interest method, would interest expense for the year ended December 31, 2010, be more than, less than, or equal to the interest expense reported using the straight-line method of discount amortization? Explain.

Discount on bonds payable is amortized with a credit, and thus increases interest expense. Under the straight-line basis, the amount of discount amortization is the same each period. Under the compound (or effective) interest method, the amount of discount amortization increases each period. Thus, interest expense under the compound method will be lower in the early years of the bonds life, and higher in the later years, as compared to interest expense under the straight-line method of amortization.