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On January 1, Year 1, Pierce Corporation issued $25,000 in 8%, 5-year bonds payable at 102. Interest payments are due each December 31. Pierce uses the straight-line method to amortize bond discounts and premiums.
-Which of the following shows the effect of the interest payment and amortization on December 31,Year 1?

Question

Quizplus · Accepted Answer

Cash interest payment = Face value of $25,000 × 8% = $2,000
Issue price = Face value of $25,000 × 102% = $25,500
Premium = Issue price of $25,500 ? Face value of $25,000 = $500
Annual amortization of premium = Premium of $500 premium ÷ 5 years = $100
Annual interest expense = Cash payment of $2,000 ? Amortization of premium of $100 = $1,900
The transaction decreases assets (cash) by $2,000, decreases liabilities (premium on bonds payable) by $100, and decreases stockholders' equity (retained earnings) by $1,900. It increases expenses (interest expense) by $1,900, which decreases net income. The cash payment of $2,000 is reported as a cash outflow for operating activities.

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