221. Silk Company issued $500,000 of 7%, 10-year bonds on its interest date for $431,850 to yield an effective annual rate of 9%. The effective-interest method of amortization is to be used. How much bond interest expense (to the nearest dollar) should be reported on the income statement for the end of the first year?

Question

Quizplus · Accepted Answer

Step 1: Calculate the annual interest payment
= 7% of $500,000
= $35,000
Step 2: Calculate the present value of the bond
Using the formula: PV = FV/(1+i)^n
PV = $431,850
FV = $500,000
i = 9%
n = 10 years
PV = $431,850 = $500,000/(1+9%)^10
Step 3: Calculate the bond discount
Bond Issued at = $431,850
Par value of bond = $500,000
Bond discount = Par value of bond - Bond Issued at
= $500,000 - $431,850
= $68,150
Step 4: Calculate the annual amortization of bond discount
= Bond discount / Number of years
= $68,150 / 10 years
= $6,815
Step 5: Calculate the interest expense for the first year
= Annual interest payment - Annual amortization of bond discount
= $35,000 - $6,815
= $28,185
Hence, the bond interest expense (to the nearest dollar) should be reported as $38,867 on the income statement for the end of the first year.