Page 617 - Accounting Principles (A Business Perspective)

15. Long-term financing: Bonds

Exhibit 125: Present value of an annuity

Such a procedure could become quite tedious if the annuity consisted of a large number of payments.
Fortunately, tables are also available showing the present values of an annuity of USD 1 per period for varying

interest rates and periods. See the end-of-text Appendix, Table A.4. For the annuity just described, you can obtain a
single factor from the table to represent the present value of an annuity of USD 1 per period for three (semiannual)
periods at 6 per cent per (semiannual) period. This factor is 2.67301; it is equal to the sum of the present value
factors for USD 1 due in one period, USD 1 in two periods, and USD 1 in three periods found in the Appendix, Table
A.3. When this factor is multiplied by USD 100, the number of dollars in each payment, it yields the present value of
the annuity, USD 267.30. In Exhibit 125, we graphically present the present value of this annuity and show how to
find the present value of the three USD 100 cash flows by multiplying the USD 100 by a present value of an annuity
factor, 2.67301.
Suppose you won a lottery that awarded you a choice of receiving USD 10,000 at the end of each of the next five

years or USD 35,000 cash today. You believe you can earn interest on invested cash at 15 per cent per year. Which
option should you choose? To answer the question, compute the present value of an annuity of USD 10,000 per
period for five years at 15 per cent. The present value is USD 33,521.60, or USD 10,000 X 3.35216. You should
accept the immediate payment of USD 35,000 since it has the larger present value.

Demonstration problem
Jackson Company issued USD 100,000 face value of 15 per cent, 20-year junk bonds on 2010 April 30. The
bonds are dated 2010 April 30, call for semiannual interest payments on April 30 and October 31, and are issued to
yield 16 per cent (8 per cent per period).
a. Compute the amount received for the bonds.
b. Prepare an amortization schedule. Enter data in the schedule for only the first two interest periods. Use the
effective interest rate method.
c. Prepare journal entries to record issuance of the bonds, the first six months' interest expense on the bonds,
the adjustment needed on 2010 December 31 (assuming Jackson's accounting year ends on that date), and the

second six months' interest expense on 2011 April 30.
Solution to demonstration problem
a.
Price received:
Present value of principal: $100,000 x 0.04603

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