Basil Corporation issues for cash $1,000,000 of 8%, 10-year bonds, interest payable annually, at a time when the market rate of interest is 7%. The straight-line method is adopted for the amortization of bond discount or premium. Which of the following statements is true?
A) The carrying amount increases from its amount at issuance date to $1,000,000 at maturity.
B) The carrying amount decreases from its amount at issuance date to $1,000,000 at maturity.
C) The amount of annual interest paid to bondholders increases over the 10-year life of the bonds.
D) The amount of annual interest expense decreases as the bonds approach maturity.

Question

Quizplus · Accepted Answer

When the market rate of interest is higher than the stated rate of interest on the bonds, they will be issued at a discount. This means that the bonds will be issued for less than their face value. The discount is amortized over the life of the bonds, which means that the carrying amount of the bonds will decrease from its amount at issuance date to $1,000,000 at maturity. The amount of annual interest paid to bondholders does not change over the life of the bonds, as it is based on the stated rate of interest. Similarly, the amount of annual interest expense also does not change, as it is based on the carrying amount of the bonds and the stated rate of interest.

Basil Corporation Issues for Cash $1,000,000 of 8%, 10-Year Bonds