On January 1,2011,Nadir Company issued $1,000,000 of 6%,20-year bonds when the market rate of interest was 5%.The bonds pay interest annually on December 31.Nadir uses the effective interest method of amortization.On its statement of cash flows for the year ended December 31,2011,Nadir will show ________ cash paid for ________ activities.

Question

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Since the bonds were issued on January 1st, 2011 and interest is paid annually on December 31st, 2011 will be the first year that Nadir will need to make an interest payment. Since the bonds pay 6% interest on a million-dollar principal, the amount of interest due on December 31st, 2011 will be $60,000 (6% x $1,000,000).
Under the effective interest method of amortization, the amount of interest expense recognized on the income statement will differ from the amount of cash paid for interest. This is because the effective interest method accounts for the difference between the bond's stated interest rate (6%) and the market rate of interest at the time the bonds were issued (5%). This difference results in a bond premium, which reduces the effective interest rate applied to the bond to less than 6%.
Since the bonds were issued at a premium and the effective interest method is used, interest expense for the year will be less than the total amount of interest paid for the year (which was $60,000). Therefore, the $60,000 cash paid for interest will be larger than the interest expense recognized on the income statement. This excess amount represents a cash outflow which is included in the operating activities section of the statement of cash flows. So the answer is $(60,000); operating.

On January 1,2011,Nadir Company Issued $1,000,000 of 6%,20-Year Bonds When