Week 13 · Assignment: Traditional alternative (no AI)

Week 13 — What the Bonds Really Cost: Discounts, Premiums, and Carrying Value — Traditional alternative (no AI)

Financial Accounting Free sample edition

Traditional alternative (no AI), unpublished. In the course this is a separate assignment that ships unpublished beside the adaptive assignment: same objective, no AI. An instructor who prefers it publishes it and unpublishes or deletes the adaptive one, as the note at its top says.

Instructors: publish this instead of the adaptive version if you prefer, and unpublish or delete the adaptive one.

Assignment 12 of the term — compute the bicycle shop's bond interest, record its bonds issued at a discount and at a premium, follow the carrying value, and set a founder straight about what the bonds really cost.

This week you met bond terms, present value, bonds issued at face, at a discount, and at a premium, straight-line amortization, interest expense and carrying value, the effective-interest method and installment notes in words, and debt on the balance sheet. In this assignment you work four short problems on the bicycle shop's bonds, interpret each one, and explain this week's ideas to someone who has them wrong. This week's lecture tutorial, quiz, discussion, and Accounting Workshop practise the same ideas from other angles. It builds on Week 5, where you split the balance sheet into current and long-term sections, on Week 11, where you spread a van's cost with the straight-line method, and on Week 12, where you recorded notes payable.

The task

This week's material is pinned. A bond's face value is repaid at maturity, its stated rate sets the cash interest paid, and the market rate is the return investors require. Bonds sell at face when the market rate equals the stated rate, at a discount when the market rate is higher, and at a premium when it is lower; the price is the present value of the bond's cash flows at the market rate. A discount is amortized over the bond's life as additional interest expense and a premium as a reduction of interest expense; the effective-interest method is the method GAAP calls for, and the straight-line method is acceptable when its results are not materially different. The carrying value is Bonds Payable minus any unamortized discount or plus any unamortized premium.

The running case is an illustrative, unnamed bicycle repair and sales shop, organized as a corporation by two founders; it describes no real business. After a later expansion it issues $100,000 of 5-year, 6 percent bonds that pay interest semiannually, and Dataset J tries them issued at face, for $96,000, and for $104,000.

One of the founders (an illustrative person) sends you this message: "If we sell the bonds for $96,000, we lose $4,000 the day we sell them. If we sell them for $104,000, we make a $4,000 profit. Either way the interest is 6 percent, so the cost of borrowing is the same." Your job is to answer the way this course would, starting from four small calculations on the shop's bonds.

Work these four problems, showing your arithmetic:

The bicycle shop issues $100,000 of 5-year, 6 percent bonds that pay interest semiannually. How much cash interest does the shop pay each period?
The bicycle shop issues its $100,000 of bonds for $96,000 and amortizes the discount by the straight-line method over 10 periods. Cash interest is $3,000 a period. What is the interest expense each period?
The bicycle shop's bonds were issued for $96,000, and straight-line amortization of the discount is $400 a period. What is the bonds' carrying value after the first period?
The bicycle shop issues the same $100,000 of bonds for $104,000. Over 10 periods it pays $3,000 of cash interest each period and repays the $100,000 face at maturity. What is the total interest expense over the bonds' life?

Beside each answer, add one brief interpretation:

Problem 1: say which rate sets the cash interest and which sets the price; then explain why the cash interest is the same whether the bonds sell for $100,000, $96,000, or $104,000.
Problem 2: write the issue entry and one period's interest entry, each with the debits first, the credits second, and equal totals; then explain why the interest expense is more than the cash interest.
Problem 3: say what carrying value means and show how the bonds appear in the long-term liabilities section of the balance sheet; then say what the carrying value will be at maturity and why.
Problem 4: write the premium issue entry and one period's interest entry, balanced and debits first, and explain why a premium lowers interest expense; then describe the effective-interest method in words, including what GAAP calls for.

Explain it to a non-expert

The founder means well and has three things wrong. Write a 3–5 sentence message that explains why the $4,000 discount is not a loss and the $4,000 premium is not a profit, and why the cost of borrowing is not the same at every price. Name one limit, such as that straight-line amortization is a simplification of the effective-interest method GAAP calls for, or that the course does not compute the market rate behind the $96,000 and $104,000 prices. Explain any technical term in everyday words. More than one good answer is possible.

For a different, ungraded example, imagine a cousin who lends a friend $900 today in return for a promise of $1,000 a year from now, and then says, "I'm out $900 now, so I lost money." Model answer: "You didn't lose anything when you handed over the $900; you made a loan that pays you back more than you lent. The extra $100 is what your friend pays you for waiting a year, so it is really interest, even though it all arrives at the end. One caveat: it only works out that way if your friend actually repays the $1,000 on time."

Use that pattern for the founder, with your own wording and evidence.

Show your arithmetic. A reader should be able to reproduce every number you report from the figures in the problems without guessing which figures or steps you used.

Deliverables

Submit a single report containing:

the four results, each with the arithmetic shown and the brief interpretation the task names for that problem;
the four journal entries (the discount issue and one interest payment, the premium issue and one interest payment), each with the debits first, the credits second, and equal totals;
the long-term liabilities lines from Problem 3, showing Bonds Payable and the unamortized discount;
your message to the founder, explaining why the discount is not a loss, why the premium is not a profit, and why the cost of borrowing differs with the price, with one limit; and
a one-line restatement of the figures you used, so your results are reproducible.

Keep it to roughly one page. Clear and correct beats long.

Choose how you show it. Present your report as written text, or as a recorded audio or video explanation of about three minutes with a transcript, or as a labelled spreadsheet of the amortization with a short explanation. Every form is graded by the same scoring criteria. Submit in any accessible file type or as a link; a recorded response may be submitted as audio or video with a transcript, or as text.

How you'll be graded

The full analytic rubric is attached to this assignment in Canvas.

Academic integrity and AI use

This version is designed to be completed without AI: do the arithmetic, the entries, the interpretations, and the writing yourself. You may use a calculator or a spreadsheet for the arithmetic. State the amortization rules only as this week's materials state them, check every entry so that its debits equal its credits, and give no tax, legal, or investment advice. Submitting work you did not write as your own, or copying another student's work, is an integrity violation under the course policy.

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