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 at the end of ten years before the final maturity payment is made?

Question

Quizplus · Accepted Answer

The effective interest method involves adjusting the carrying amount of the bond for the amortization of the discount or premium over the life of the bond. Since the bonds were issued at a premium (issued for $1,150,000 when the face value is $1,000,000), the premium of $150,000 will be amortized over the 10-year life of the bonds.
The carrying value of the bonds will decrease over time as the premium is amortized. The interest expense recorded each period is based on the market rate at the time of issuance (8%) multiplied by the carrying value of the bonds at the beginning of the period.
At the end of the ten-year period, the carrying value of the bonds will be equal to their face value because the entire premium will have been amortized. The bonds were issued at a premium to adjust the effective interest rate to the market rate. Over the life of the bonds, this premium is amortized, and the carrying value of the bonds approaches their face value.
Therefore, the correct answer is:
c. $1,000,000
This is the face value of the bonds, which is also the carrying value at the end of the ten-year period before the final maturity payment is made, as the entire premium has been amortized by that time.

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