Designer Company issued 10-year bonds on January 1. The 6% bonds have a face value of $800,000 and pay interest every January 1 and July 1. The bonds were sold for $690,960 based on the market interest rate of 8%. Designer uses the effective interest method to amortize bond discounts and premiums. On July 1 of the first year, Designer should record an interest expense (round to the nearest dollar) of

A) $27,638
B) $24,000
C) $48,000
D) $55,277

Question

Morgan Phillips · Accepted Answer

Final Answer : A, Explanation :  First, we need to calculate the annual interest payment: Face value x coupon rate = $800,000 x 6% = $48,000. This is split into two payments of $24,000 each, due every January 1 and July 1.Next, we need to calculate the bond discount: Face value - selling price = $800,000 - $690,960 = $109,040.We can use this information to calculate the effective interest rate:Annual interest payment / Beginning book value = $48,000 / $690,960 = 6.95%.Using the effective interest method, we allocate the total interest expense over the life of the bond.For the first six months, we take the beginning book value of $690,960 and multiply it by half the effective interest rate: $690,960 x 3.475% = $24,000. This is the interest expense recorded on January 1.On July 1, we need to record the interest expense for the next six months. To do this, we first need to calculate the new book value:Beginning book value + (interest expense - interest payment) = $690,960 + ($24,000 - $24,000) = $690,960.Then we can calculate the interest expense: New book value x half the effective interest rate = $690,960 x 3.475% = $24,638.Rounding this to the nearest dollar gives us an interest expense of $27,638, which corresponds to answer choice A.

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