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. What is the carrying value of the bonds after the first interest payment is made on June 30, 2019?

Question

Quizplus · Accepted Answer

To determine the carrying value of the bonds after the first interest payment on June 30, 2019, we need to follow these steps:
1. Calculate the initial bond premium.
2. Determine the interest expense using the effective interest method.
3. Calculate the bond carrying value after the first interest payment.
Step 1: Calculate the initial bond premium.
The bonds were issued for $1,150,000, which is more than the face value of $1,000,000 (1,000,000 bonds at $1 each). This means there is a bond premium of $150,000 ($1,150,000 - $1,000,000).
Step 2: Determine the interest expense using the effective interest method.
The interest expense is calculated using the market rate of interest, which is 8%. Since interest is paid semiannually, we use half of the annual market rate for the calculation.
Interest expense for the first six months = Carrying value of the bonds at the beginning * Market interest rate/2
Interest expense for the first six months = $1,150,000 * (8% / 2)
Interest expense for the first six months = $1,150,000 * 0.04
Interest expense for the first six months = $46,000
Step 3: Calculate the bond carrying value after the first interest payment.
The cash paid for interest is based on the stated rate of 10%, which is also paid semiannually.
Cash paid for interest = Face value of the bonds * Stated interest rate/2
Cash paid for interest = $1,000,000 * (10% / 2)
Cash paid for interest = $1,000,000 * 0.05
Cash paid for interest = $50,000
The premium amortization for the first six months is the difference between the cash paid for interest and the interest expense.
Premium amortization = Cash paid for interest - Interest expense
Premium amortization = $50,000 - $46,000
Premium amortization = $4,000
Now, we subtract the premium amortization from the initial bond premium to find the new premium.
New bond premium = Initial bond premium - Premium amortization
New bond premium = $150,000 - $4,000
New bond premium = $146,000
Finally, we add the new bond premium to the face value of the bonds to find the carrying value after the first interest payment.
Carrying value after first interest payment = Face value of the bonds + New bond premium
Carrying value after first interest payment = $1,000,000 + $146,000
Carrying value after first interest payment = $1,146,000
Therefore, the correct answer is:
b. $1,146,000

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