On January 1, a company issues bonds dated January 1 with a par value of $400,000. The bonds mature in 5 years. The contract rate is 7%, and interest is paid semiannually on June 30 and December 31. The market rate is 8% and the bonds are sold for $383,793.
-The journal entry to record the first interest payment using the effective interest method of amortization is:
A) Debit Interest Payable $14,000.00; credit Cash $14,000.00.
B) Debit Interest Expense $15,351.72; credit Premium on Bonds Payable $1,351.72; credit Cash $14,000.00.
C) Debit Interest Expense $12,648.28; debit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00.
D) Debit Interest Expense $15,351.72; credit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00.
E) Debit Interest Expense $12,648.28; debit Premium on Bonds Payable $1,351.72; credit Cash $14,000.00.

Question

On January 1, a company issues bonds dated January 1 with a par value of $400,000. The bonds mature in 5 years. The contract rate is 7%, and interest is paid semiannually on June 30 and December 31. The market rate is 8% and the bonds are sold for $383,793. 
-The journal entry to record the first interest payment using the effective interest method of amortization is:
A) Debit Interest Payable $14,000.00; credit Cash $14,000.00.
B) Debit Interest Expense $15,351.72; credit Premium on Bonds Payable $1,351.72; credit Cash $14,000.00.
C) Debit Interest Expense $12,648.28; debit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00.
D) Debit Interest Expense $15,351.72; credit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00.
E) Debit Interest Expense $12,648.28; debit Premium on Bonds Payable $1,351.72; credit Cash $14,000.00.

Quizplus · Accepted Answer

Under the effective interest method, the interest expense is calculated by using the market rate of interest at the time of issuance to discount the cash flows associated with the bond. The difference between the cash interest payment and the interest expense is used to either reduce the premium or increase the discount on bonds payable.

For the first interest payment, the interest expense is calculated as follows:

First, calculate the semi-annual interest payment: 
$400,000 x 7% x 6/12 = $14,000

Next, calculate the interest expense: 
Interest expense = $383,793 x 8% x 6/12 = $15,351.72

The difference between the interest expense and the cash payment is a reduction in the discount on bonds payable.

Therefore, the journal entry to record the first interest payment is: 
Debit Interest Expense $15,351.72; credit Discount on Bonds Payable $1,351.72; credit Cash $14,000.00.

On January 1, a Company Issues Bonds Dated January 1