Kalahari Limited
On January 2, 2019, this company issued 1,000,000, 10-year bonds for $1,150,000. The bonds pay interest on June 30 and December 31. The stated rate is 10% and the market rate is 8%. The company plans to use the effective interest method of amortizing bond discounts and premiums.
-Refer to Kalahari Limited. The interest expense on the bonds at June 30, 2019 is

Question

Quizplus · Accepted Answer

To calculate the interest expense on the bonds at June 30, 2019, using the effective interest method, we need to follow these steps:
1. Determine the carrying amount of the bonds at the beginning of the period.
2. Apply the market interest rate (effective interest rate) to the carrying amount to find the interest expense.
3. Calculate the actual cash paid for interest based on the stated rate.
Given:
- Face value of the bonds: $1,000,000
- Issue price of the bonds: $1,150,000 (since it's more than the face value, this is a premium)
- Stated interest rate: 10%
- Market interest rate: 8%
- Interest payment dates: June 30 and December 31 (semi-annually)
- Effective interest method is used for amortization.
The bonds were issued at a premium because the issue price is greater than the face value. The premium on the bonds is $150,000 ($1,150,000 - $1,000,000).
The carrying amount of the bonds at the beginning (January 2, 2019) is the issue price, which is $1,150,000.
The interest expense for the period is calculated by applying the market rate to the carrying amount:
Interest expense = Carrying amount × Market interest rate × Time period
Interest expense = $1,150,000 × 8% × (6/12)
Note that we use 6/12 because the interest is being calculated for half a year (January to June).
Interest expense = $1,150,000 × 0.08 × 0.5
Interest expense = $46,000
Therefore, the correct answer is:
b. $46,000
This is the interest expense that will be recognized in the income statement for the period ending June 30, 2019, using the effective interest method.

Kalahari Limited On January 2, 2019, This Company Issued 1,000,000, 10-Year Bonds