On January 1, 2013, $1,000,000, 5-year, 5% bonds, were issued for $957,349. The interest rate in effect when the bonds were issued was 6%. Interest is paid semi-annually on January 1 and July 1. What would be the amount of discount amortized on July 1, 2013?
A) $2,000
B) $3,720
C) $9,400
D) $2,350

Question

Quizplus · Accepted Answer

The discount on the bonds is the difference between the face value ($1,000,000) and the issued price ($957,349), which is $42,651. The discount is amortized over the life of the bond using the effective interest method. For the first six months, the interest expense is calculated on the carrying amount of the bond at the effective interest rate (6% annually, or 3% semi-annually). The carrying amount at issuance is $957,349, so the interest expense for the first six months is $957,349 * 3% = $28,720. The cash paid for interest is the face value times the stated interest rate (5% annually, or 2.5% semi-annually), which is $1,000,000 * 2.5% = $25,000. The difference between the interest expense and the cash paid is the amount of discount amortized, which is $28,720 - $25,000 = $3,720.

On January 1, 2013, $1,000,000, 5-Year, 5% Bonds, Were Issued