On January 1, 2011, Ozark Minerals issued $10 million of 9%, 10-year convertible bonds at 101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of Ozark's no par common stock. Bonds that are similar in all respects, except that they are nonconvertible, currently are selling at 99. Upon issuance, Ozark should Credit premium on bonds payable $100,000. Why?

Explanation:

Bonds are corporate debt units that are issued by firms inform of financial securities and  are traded as tradeable assets. It is basically referred to as a fixed income instrument since bonds conventionally are paid a certain fixed amount of interest rate (coupon) to its respective debtholders.

going by the question Upon issuance, Ozark should

Credit premium on bonds payable $100,000

Because face value of bonds =  $10 million but issue price is  $10 million * 101 % i.e $ 10100000

So, premium = 10100000 - 10000000 = $ 100000

The rationale for crediting premium on bonds payable with $100,000 is that premium on the bonds issuance is $100,000 as shown below.

Explanation:

The total cash proceeds realized from the bond issuance is $10,100,000($10,000,000*101%=$ 10,100,000) which is automatically debited to cash/bank account  since it is an inflow of cash.

However, the corresponding credit entry should be broken into par value which goes into the bonds payable account as the amount owed to bondholders and the extra shows up in bonds premium account, the analysis is done below:

Cash proceeds                                                     $10,100,000

less;amount credited to bonds payable  

100/101*$10,100,000                                           ($10,000,000)

Balancing figure(premium on bonds)                      $100,000

The premium can also be computed in an alternative way shown below

(premium)/(premium+par)*cash proceeds

1/(1+100)*$10,100,000                                         $100,000    

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