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On 1 July 2015 Kruger Ltd privately issues $1 million in six-year debentures, which pay interest every six months at a coupon rate of 6 per-cent per annum
On 1 July 2015 Kruger Ltd privately issues $1 million in six-year debentures, which pay interest every six months at a coupon rate of 6 per-cent per annum. At the time of issuing the securities, the market requires a rate of return of 4 per-cent. Consistent with the requirements of AASB 9, the debentures are accounted for using the effective interest method.
Required:
(a) Determine the fair value of the debentures at the time of issue (which will also be their issue price).
(b) Provide the journal entries at:
(i) 1 July 2015
(ii) 31 December 2015
(iii) 30 June 2016.
Expert Solution
(a)
Semi−annual coupon rate = Coupon rate2Semi−annual coupon rate = 6%2Semi−annual coupon rate = 3%Semi−annual coupon rate = Coupon rate2Semi−annual coupon rate = 6%2Semi−annual coupon rate = 3%
Semi−annual market rate = Market rate2Semi−annual market rate = 4%2Semi−annual market rate = 2%Semi−annual market rate = Market rate2Semi−annual market rate = 4%2Semi−annual market rate = 2%
Present value of interest = Value of debentures × Semi−annual coupon rate × 1 − (1 + Semi−annual market rate)−12Semi−annual market ratePresent value of interest = 1,000,000 × 3% × 1 − (1 + 2%)−122%Present value of interest = 1,000,000 × 0.03 × 1 − (1 + 0.02)−120.02Present value of interest = 30,000 × 10.5753Present value of interest = $317,260Present value of interest = Value of debentures × Semi−annual coupon rate × 1 − (1 + Semi−annual market rate)−12Semi−annual market ratePresent value of interest = 1,000,000 × 3% × 1 − (1 + 2%)−122%Present value of interest = 1,000,000 × 0.03 × 1 − (1 + 0.02)−120.02Present value of interest = 30,000 × 10.5753Present value of interest = $317,260
Present value of principal = Value of debentures × 1(1 + Semi−annual market rate)12Present value of principal = 1,000,000 × 1(1 + 2%)12Present value of principal = 1,000,000 × 0.788493Present value of principal = $788,493Present value of principal = Value of debentures × 1(1 + Semi−annual market rate)12Present value of principal = 1,000,000 × 1(1 + 2%)12Present value of principal = 1,000,000 × 0.788493Present value of principal = $788,493
Fair value of the debentures at the time of issue or issue price = Present value of interest + Present value of principal
Fair value of the debentures at the time of issue or issue price = 317,260 + 788,493
Fair value of the debentures at the time of issue or issue price = $1,105,753
(b)
(i)
| Date | Particulars | Debit | Credit |
|---|---|---|---|
| 1/07/2015 | Cash | 1,105,753 | |
| Debentures | 1,105,753 |
(ii)
| Date | Particulars | Debit | Credit |
|---|---|---|---|
| 31/12/2015 | Interest expense (WN A) | 22,115.06 | |
| Debentures | 7,884.94 | ||
| Cash (WN B) | 30,000 |
Working Notes:
A. Interest expense = 1,105,753 * 2% = $22,115.06
B. Cash = 1,000,000 * 3% = $30,000
(iii)
| Date | Particulars | Debit | Credit |
|---|---|---|---|
| 30/06/2016 | Interest expense (WN C) | 21,957.36 | |
| Debentures | 8,042.64 | ||
| Cash (WN D) | 30,000 |
Working Notes:
C. Interest expense = 1,097,868 * 2% = $21,957.36
D. Cash = 1,000,000 * 3% = $30,000
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