On January 2, 2020, McIntosh Ltd. sold five year, 4% bonds with a face value of $ 500,000. Interest will be paid semi-annually on June 30 and December 31. The bonds were sold for $ 478,121 to yield 5%. Using the effective-interest method of amortization of bond discount or premium, interest expense for 2020 is

Question

Quizplus · Accepted Answer

The interest expense for 2020 using the effective-interest method is calculated by applying the market interest rate (5% annual, or 2.5% semi-annual) to the carrying amount of the bonds at the beginning of each period. The carrying amount at the start is $478,121. For the first six months, the interest expense is $478,121 * 2.5% = $11,953. For the next six months, the carrying amount is adjusted by adding the previous interest expense minus the actual cash paid for interest ($11,953 - ($500,000 * 2% = $10,000)) = $1,953. So, the new carrying amount is $478,121 + $1,953 = $480,074. The interest expense for the next six months is $480,074 * 2.5% = $12,002. The total interest expense for 2020 is $11,953 + $12,002 = $23,955.