Cotton Company issued $500000 of 7% 10-year bonds on one of its interest dates for $431850 to yield an effective annual rate of 9%. The effective-interest method of amortization is to be used. Interest is paid annually. The journal entry on the first interest payment date to record the payment of interest and amortization of discount will include a

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The effective interest method involves calculating interest expense based on the carrying amount of the bond and the effective interest rate. The carrying amount of the bond is its face value minus any unamortized discount. In this case, the bond was issued at a discount ($431,850 < $500,000 face value), and the effective annual interest rate is 9%. The interest expense for the first year is calculated as the carrying amount of the bond ($431,850) times the effective interest rate (9%), which equals $38,866.50 (rounded to $38,867 for simplicity). The actual cash paid for interest is the bond's stated rate (7%) times its face value ($500,000), which equals $35,000. The difference between the interest expense ($38,867) and the cash paid ($35,000) is $3,867, which is the amount of discount amortized for the year. Therefore, the correct entry includes crediting Discount on Bonds Payable for $3,867 to recognize the amortization of the discount.

Cotton Company Issued $500000 of 7% 10-Year Bonds on One