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Gabriel Co. produces and distributes semiconductors for use by computer manufacturers. Gabriel Co. issued $600,000 of 10-year, 8% bonds on May 1 of the current year at face value, with interest payable on May 1 and November 1. The fiscal year of the company is the calendar year.

Journalize the entries to record the following selected transactions for the current year

May	1	Issued the bonds for cash at their face amount.
Nov.	1	Paid the interest on the bonds.
Dec.	31	Recorded accrued interest for two months.

GENERAL JOURNAL						Page
	Date		Description	Post ref	Debit	Credit
1							1
2							2
3							3
4							4
5							5
6							6
7							7
8							8
9							9

Discount: Contract Rate < Market Rate

Your bonds pay 10% when the market rate is 12%. Investors will not want to buy your bond if they can earn 12% elsewhere. What can you do to get investors to buy your 10% bond? Answer: lower the price.

You will need to drop the price of your bond so the investors are really getting a 12% return. In other words, you need to drop the price to the present value of the bond using a 12% interest rate. You will need to sell the bond at a discount.

The Company issues $1,000,000 5-year bonds with a contract rate of 10% with semi-annual interest payments when the market rate is 12%. Using Present Value tables we determine that an issue price of $926,395 will effectively make our bonds equal to bonds that pay the market 12%.

The journal entry to record issuing the bond is:

GENERAL JOURNAL						Page
	Date		Description	Post	Debit	Credit
1							1
2							2
3							3

Discount on Bonds Payable is a contra account which reduces the bonds payable account on the balance sheet. The normal balance of Discount on Bonds Payable is a debit.

For loaning the company $926,395, over the 5 year period the investor will get:

Principal $1,000,000

Interest Payments 500,000

Total 1,500,000

Investment 926,395

Interest Earned $ 573,605

The Borrowing Company will incur $573,605 of interest expense

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