A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2014. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,144. Using effective-interest amortization, how much interest expense will be recognized in 2014?

Question

Quizplus · Accepted Answer

To calculate interest expense using effective-interest amortization, we first need to calculate the interest payment and the amortization of the bond discount or premium.

Step 1: Calculate the semi-annual interest payment 
$20,000,000 x 7.8% x 6/12 = $780,000

Step 2: Calculate the bond discount 
Bond proceeds - face value = Bond discount 
$19,604,144 - $20,000,000 = $395,856

Step 3: Calculate the bond amortization using the effective-interest method 
Year 1, 1st interest payment: 
Bond carrying value x market rate per period = Interest expense 
($19,604,144 + $395,856) x 4% = $868,017

Carrying value at end of year 1: 
Carrying value at beginning of year - Amortization of bond discount + Interest expense 
$19,604,144 - $868,017 + $780,000 = $19,516,127

Year 1, 2nd interest payment: 
Bond carrying value x market rate per period = Interest expense 
($19,516,127 + $395,856) x 4% = $869,147

Total interest expense for 2014 = $868,017 + $869,147 = $1,737,164

Therefore, the correct choice is C) $1,568,498.

A Company Issues $20,000,000, 7