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On January 1 Year 1, Gordon Corporation issued bonds with a face value of $70,000, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds were issued at 98. Interest is payable in cash on December 31 each year. Gordon uses the straight-line method to amortize bond discounts and premiums.
-Which of the following shows the effect of the first interest payment and amortization of the premium or discount on the elements of the financial statements?

Question

Quizplus · Accepted Answer

Issue price = Face value of $70,000 × 98% = $68,600
Discount = Face value of $70,000 ? Issue price of $68,600 = $1,400
Annual amortization of discount = $1,400 ÷ 5 years = $280
Cash interest payment = Face value of $70,000 × 6% = $4,200
Interest expense = Cash payment of $4,200 + Amortization of discount of $280 = $4,480
This transaction decreases assets (cash) by $4,200, increases liabilities (by decreasing discount on bonds payable, a contra-liability account) by $280, and decreases stockholders' equity (retained earnings) by $4,480. It increases expenses (interest expense) by $4,480 and decreases net income by the same amount. The cash interest payment of $4,200 is reported as a cash outflow for operating activities.

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