Silcon Company issued $500,000 of 6%, 10-year bonds on one of its interest dates for $431,850 to yield an effective annual rate of 8%. 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

First, we need to calculate the amount of annual interest payments. The bond has a face value of $500,000 and an annual coupon rate of 6%, so the annual interest payment is:

$500,000 x 6% = $30,000

Next, we need to calculate the amount of interest expense for the first year of the bond's life. We know that the bond was sold for $431,850, which is less than the face value of $500,000. This means that the bond was sold at a discount. The amount of the discount is the difference between the face value and the selling price:

$500,000 - $431,850 = $68,150

We also know that the effective annual rate is 8%. Using this information and the amount of the discount, we can calculate the amount of interest expense for the first year using the effective-interest method of amortization:

Interest expense = Effective interest rate x Carrying Value of the Bond

Carrying value of the bond at the end of the first year = Face value of the bond - Amount of amortization for the first year

The amount of amortization is the difference between the annual interest payment and the interest expense for the year. We can calculate the effective interest rate using the formula:

Effective interest rate = (1 - Selling price / Face value) x Annual interest rate

Effective interest rate = (1 - $431,850 / $500,000) x 6% = 8%

So, the carrying value of the bond at the end of the first year is:

$500,000 - ($68,150 / 10) = $433,185

The interest expense for the first year is:

Interest expense = 8% x $433,185 = $34,548.

Silcon Company Issued $500,000 of 6%, 10-Year Bonds on One