Buderup Ltd issues $9 million in 12-year,6%,semi-annual coupon debentures.The rate of return required by the market is 10% per annum.What are the journal entries to record the first and second payments of interest assuming that Buderup uses the effective-interest method to amortise any discount or premium (rounded to the nearest dollar)?

Question

Quizplus · Accepted Answer

The effective interest method is used to amortize any discount or premium on the debentures, which means that the interest expense recorded in the journal entries will vary from the coupon payments.

For the first payment of interest: 
Debit Interest Expense: $442,200 (calculated as $9,000,000 x 5% effective interest rate x 6/12) 
Debit Discount on Debentures: $23,900 (calculated as $442,200 - $418,300 coupon payment) 
Credit Cash: $418,300 (semi-annual coupon payment)

For the second payment of interest: 
Debit Interest Expense: $437,780 (calculated as [$9,000,000 - $23,900] x 5% effective interest rate x 6/12) 
Debit Discount on Debentures: $9,720 (calculated as $437,780 - $428,060 coupon payment) 
Credit Cash: $428,060 (semi-annual coupon payment)

Therefore, option C is the correct answer.

Buderup Ltd Issues $9 Million in 12-Year,6%,semi-Annual Coupon Debentures