A company issues 10 debentures of Rs 5,00,000 each, bearing 10% annual interest, at 99% of face value. Issue expenses are Rs 5,000 per debenture and a 20% discount on these costs is allowed. The debentures have a tenure of 5 years. Calculate: (a) the amount to be shown in the Debentures Account, (b) net cash received, (c) annual amortization of the discount on issue expenses, and (d) total interest expense for the first year including amortization.
Answer
4950000; 4940000; 2000; 502000
The correct answer is 4950000; 4940000; 2000; 502000 — Add amortization of discount: 5,00,000 + 20,000 = Rs 5,20,000 – total interest expense for first year
Step-by-step solution
- Compute issue price per debenture: 99% of Rs 5,00,000 = 0.99 × 5,00,000 = Rs 4,95,000
- Multiply by 10 debentures: 4,95,000 × 10 = Rs 49,50,000 – amount credited to Debentures Account
- Compute total issue expenses: 5,000 × 10 = Rs 5,00,000
- Compute discount on issue expenses: 20% of 5,00,000 = 1,00,000
- Net cash received: 49,50,000 – 1,00,000 = Rs 49,40,000
- Compute annual amortization of discount on issue expenses: 1,00,000 ÷ 5 = Rs 20,000? Wait – correct calculation: 1,00,000 ÷ 5 = 20,000? But the discount is 1,00,000, not 10,000. Recalculate: 5,000 × 10 = 5,00,000; 20% of 5,00,000 = 1,00,000; 1,00,000 ÷ 5 = 20,000 per year.
- Compute annual interest expense: 10% of face value per debenture = 0.10 × 5,00,000 = Rs 50,000; for 10 debentures = 5,00,000
- Add amortization of discount: 5,00,000 + 20,000 = Rs 5,20,000 – total interest expense for first year
Common mistake: Using wrong discount amount or forgetting to add amortization to interest expense
Concept tested: Amortization of discount on issue costs and interest expense
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