Eaton Company issued $5 million of bonds. The stated rate of interest was 10% and the market rate was 11%. Which of the following statements is correct?
A) The bonds were issued at a premium.
B) Annual interest expense will exceed the company's actual cash payments for interest.
C)Annual interest expense will be $500,000.
D)The book value of the bond will decrease as the bond matures.

Question

Quizplus · Accepted Answer

Since the market rate is higher than the stated rate, the bonds were issued at a discount instead of a premium. The annual interest expense will be higher than $500,000 (10% of $5 million) because it will be calculated based on the market rate of 11%. As a result, the company will have to pay more in interest than the amount received in cash. The book value of the bond will decrease over time as a portion of the discount is amortized each year.

Eaton Company Issued $5 Million of Bonds