On January 1 Shade Corporation issued $3000000 7% 5-year bonds with interest payable on December 31. The bonds sold for $3216288. The market rate of interest for these bonds was 6%. On the first interest date using the effective-interest method the debit entry to Interest Expense is for

A) $180000.
B) $225140.
C) $192977.
D) $210000.

Question

Robert Cortez · Accepted Answer

Final Answer : C, Explanation :  Using the effective-interest method, the interest expense is calculated as follows:Interest Expense = Carrying Value x Market Interest RateCarrying Value = Initial Bond Proceeds - (Total Amortization of Discount)Total Amortization of Discount = ($3216288 - $3000000)/5 years = $434576Carrying Value for the first interest payment = $3216288 - $434576 = $2781712Interest Expense = $2781712 x 6% = $166902.72 for the first year.Therefore, the debit entry to Interest Expense is $192977 (rounded to the nearest dollar). To calculate the interest expense using the effective-interest method, we need to first calculate the carrying value of the bond at the beginning of the interest period.Carrying value on January 1: $3,216,288To calculate carrying value on June 30, we need to calculate the interest expense and subtract it from the carrying value:Interest expense for 6 months = $3,216,288 x 6% x (6/12) = $96,485.64Carrying value on June 30 = $3,216,288 - $96,485.64 = $3,119,802.36To calculate the interest expense for the first interest date, we need to calculate the difference between the carrying value at the beginning of the interest period and the carrying value at the end of the interest period, and multiply it by the market rate of interest:Interest expense for first interest date = ($3,216,288 - $3,119,802.36) x 6% = $96,485.64Therefore, the debit entry to Interest Expense is $192,977.28 ($96,485.64 x 2, since interest is paid semi-annually).

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