On January 1,ABC,Inc. ,issued $100,000 of 10%,5-year bonds on January 1,2018,for $92,280.Interest is due semiannually.When ABC records the first interest payment,which will be greater the debit to Interest Expense or the credit to Cash?
A)The debit to Interest Expense will be greater because the market rate is greater than the stated interest rate.
B)The debit to Interest Expense will be less because the market rate is greater than the stated interest rate.
C)The debit to Interest Expense will be greater because the market rate is less than the stated interest rate.
D)The debit to Interest Expense will be lower because the market rate is less than the stated interest rate.

Question

Quizplus · Accepted Answer

The bond sold at a discount because the stated rate is lower than the market rate of interest.The discount represents an extra cost of borrowing,over and above each interest payment.For accounting purposes,we match the extra borrowing cost to the periods in which interest is recorded.This amortization causes the Interest Expense to be more than the interest payment and,at the same time,causes Discount on Bonds Payable to decrease each period.(As a result,the debit to Interest Expense will be greater because it is based on the market rate. )As the Discount on Bonds Payable decreases,the carrying value of the liability increases until it reaches the face value of the bonds on the maturity date.