Sparks Company received proceeds of $634,500 on 10-year, 8% bonds issued on January 1, 2016. The bonds had a face value of $600,000, pay interest annually on December 31st, and have a call price of 102. Sparks uses the straight-line method of amortization. What is the carrying value of the bonds on January 1, 2018?
A)$600,000
B)$627,600
C)$572,400
D)$631,050

Question

Quizplus · Accepted Answer

First, let's calculate the annual interest payments:

Annual interest = Face value x Annual interest rate 
Annual interest = $600,000 x 8% 
Annual interest = $48,000

Since the bonds were issued on January 1, 2016 and pay interest annually on December 31st, there were two interest payments made by December 31, 2017. Therefore, the total amount of interest accrued on the bonds is:

Total interest accrued = Annual interest x Number of payments made 
Total interest accrued = $48,000 x 2 
Total interest accrued = $96,000

To calculate the bond discount or premium, we need to find the difference between the proceeds received and the face value of the bonds:

Bond discount/premium = Proceeds received - Face value 
Bond discount/premium = $634,500 - $600,000 
Bond discount/premium = $34,500

Since the bond has a call price of 102, this means that the company can call the bonds at 102% of the face value before the maturity date. In other words, if the call price is higher than the carrying value of the bonds, it is advantageous for the company to call the bonds and issue new bonds at a lower interest rate. Therefore, we need to calculate the carrying value of the bonds as at January 1, 2018, and compare it to the call price.

To calculate the carrying value, we need to divide the bond discount/premium by the number of payment periods and subtract it from the face value:

Carrying value = Face value - (Bond discount/premium ÷ Number of payment periods) 
Carrying value = $600,000 - ($34,500 ÷ 10) 
Carrying value = $600,000 - $3,450 
Carrying value = $596,550

Therefore, the carrying value of the bonds as at January 1, 2018, is $596,550 which is less than the call price of 102% of the face value ($612,000). This means that it is not advantageous for the company to call the bonds at this point. The answer is B) $627,600.

Sparks Company Received Proceeds of $634,500 on 10-Year, 8% Bonds