Use the following information for questions.
Patton Company purchased $400,000 of 10% bonds of Scott Co.on January 1, 2011, paying $376,100.The bonds mature January 1, 2021; interest is payable each July 1 and January 1.The discount of $23,900 provides an effective yield of 11%.Patton Company uses the effective-interest method and holds these bonds for collection.
-For the year ended December 31, 2011, Patton Company should report interest revenue from the Scott Co.bonds of:

Question

Quizplus · Accepted Answer

The interest revenue from the Scott Co. bonds for the year ended December 31, 2011 would be calculated using the effective-interest method. This method takes into account both the stated interest rate and the discount or premium on the bonds. Using the effective-interest method, the interest revenue for 2011 can be calculated as follows:

Interest revenue = carrying value of the bonds x effective interest rate
Carrying value of the bonds = purchase price - discount amortization
Discount amortization = (purchase price - face value) / number of periods
Effective interest rate = (total interest over the life of the bond / carrying value of the bond)

Carrying value of the bond as of January 1, 2011 = $376,100
Discount on the bond as of January 1, 2011 = $23,900
Face value of the bond = $400,000
Number of periods (semi-annual) = 20
Total interest over the life of the bond = ($400,000 x 10% x 20) = $800,000
Effective interest rate = 11%

Discount amortization for the first semi-annual period = ($23,900 / 20) = $1,195
Carrying value of the bond as of July 1, 2011 = ($376,100 - $1,195) = $374,905

Interest revenue for the first semi-annual period = ($374,905 x 11%) = $41,239.55

Discount amortization for the second semi-annual period = ($23,900 - $1,195) / 20 = $1,142.75
Carrying value of the bond as of December 31, 2011 = ($374,905 + $1,142.75) = $376,047.75

Interest revenue for the second semi-annual period = ($376,047.75 x 11%) = $41,168.25

Therefore, the total interest revenue for 2011 is ($41,239.55 + $41,168.25) = $82,407.80, which is closest to choice B ($41,409).

Use the Following Information for Questions