Merchant Company issued 10-year bonds on January 1. The 15% bonds have a face value of $100,000 and pay interest every January 1 and July 1. The bonds were sold for $117,205 based on the market interest rate of 12%. Merchant uses the effective interest method to amortize bond discounts and premiums. On July 1 of the first year, Merchant should record interest expense (round to the nearest dollar) of

A) $7,032
B) $7,500
C) $8,790
D) $14,065

Question

Luis E Ramirez · Accepted Answer

Final Answer : A, Explanation :  Interest expense is calculated using the effective interest method, which involves applying the market interest rate at the time of issuance to the carrying amount of the bonds. The carrying amount initially is the price at which the bonds were sold, $117,205. The market interest rate is 12%, so the semiannual interest rate (since interest is paid every six months) is 6% (12% annual rate divided by 2). Therefore, the interest expense for the first six months is 6% of $117,205, which equals $7,032.30 (rounded to the nearest dollar gives $7,032).

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