On 1 July 2015 Kruger Ltd privately issues 1 million in sixy

On 1 July 2015 Kruger Ltd privately issues $1 million in six-year debentures, which pay interest each 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.  

Solution

(a).

Fair value of the debentures at the time of issue or Issue price =

(Present value of interest + Present value of principal)

So let’s calculate present value of interest and present value of principal one by one;

Following information are available in the question;

Coupon rate = 6% per annuam

So coupon rate for 6 month = 3%

Market interest rate = 4% per annum

So coupon rate for 6 month = 2%

Value of debentures = $1000000

Present value of interest will be calculated as follow;

10^6* 0.03* (1 - 1.02^-12)/(0.02) = $317260

Present value of principal will be calculated as follow;

10^6* 1.02^-12 = $788493

Thus fair value of the debentures at the time of issue or Issue price =

($317260 + $788493) = $1105753

(b) (i).

Date

Accounts Titles & Explanation

Debit

Credit

2015

1 July

Cash

$1105753

     Debentures

$1105753

(For recording issue of debentures)

(b) (ii).

Date

Accounts Titles & Explanation

Debit

Credit

2015

31 December

Interest expense

$22115.06

Debentures

$7884.94

     Cash

$30000

(For recording interest expense of debentures)

Working Note:

Interest expense = 1105753* 0.02 = 22115.06

Semi annual payment = 10^6*.03 = 30000

(b) (iii).

Date

Accounts Titles & Explanation

Debit

Credit

2016

30 June

Interest expense

$21957.36

Debentures

$8042.64

     Cash

$30000

(For recording interest expense of debentures)

Working Note:

Interest expense = 1097868* 0.02 = 21957.36

Semi annual payment = 10^6*.03 = 30000

Date	Accounts Titles & Explanation	Debit	Credit
2015
1 July	Cash	$1105753
	Debentures		$1105753
	(For recording issue of debentures)