On January 1, 20A, Winston Corporation sold a four-year, $10,000, 7% bond. The interest is payable annually each December 31. The issue price was $9,668 based on an 8% effective interest rate. Assuming effective-interest amortization is used, the interest expense on the 20A income statement would be which of the following amounts (to the nearest dollar)?

Question

Quizplus · Accepted Answer

First, we need to calculate the annual interest payment:
$10,000 × 7% = $700
Next, we need to calculate the annual amortization of the bond discount:
$9,668 × 8% = $773.44
Since the effective interest rate is 8%, the amortization amount will gradually increase each year so that the total interest expense over the life of the bond equals the difference between the face value of the bond and the issue price. The remaining calculations for each year are as follows:

- Year 1: 
Interest expense = $700
Amortization of bond discount = $773.44
Total interest expense = $700 + $773.44 = $1,473.44

- Year 2: 
Interest expense = $700
Amortization of bond discount = $843.05 ($9,441.55 remaining book value × 8%)
Total interest expense = $700 + $843.05 = $1,543.05

- Year 3: 
Interest expense = $700
Amortization of bond discount = $919.32 ($8,522.23 remaining book value × 8%)
Total interest expense = $700 + $919.32 = $1,619.32

- Year 4: 
Interest expense = $700
Amortization of bond discount = $1,002.19 ($7,520.04 remaining book value × 8%)
Total interest expense = $700 + $1,002.19 = $1,702.19

Therefore, the interest expense on the 20A income statement would be $1,544 if rounded to the nearest dollar.

On January 1, 20A, Winston Corporation Sold a Four-Year, $10,000