Weller Company issued bonds with a face value of $400,000, a 10% stated rate of interest, and a 10-year term. The bonds were issued on January 1, Year 1, and Weller uses the effective interest method of amortization. The market rate of interest on the date of issue was 8%. Interest is paid annually on December 31.Assuming Weller issued the bond for $453,681, the amount of interest expense appearing on the Year 3 income statement would be closest to:
A) $35,678.
B) $44,322.
C) $35,998.
D) $35,332.

Question

Quizplus · Accepted Answer

The correct answer is A.The amount of interest expense appearing on the Year 3 income statement would be closest to $35,678. This is because the effective interest method of amortization allocates the interest expense over the life of the bond based on the market rate of interest at the time of issuance. In this case, the market rate of interest was 8%, so the interest expense for each year would be $400,000 x 8% = $32,000. However, because the bonds were issued at a premium, the carrying value of the bonds will decrease over time. This means that the interest expense will also decrease slightly each year. In Year 3, the carrying value of the bonds will be $453,681 - $32,000 x 2 = $389,681. The interest expense for Year 3 will therefore be $389,681 x 8% = $35,678.

Weller Company Issued Bonds with a Face Value of $400,000