On July 1,2016,Cargo Corporation issues $4,000,000 of 10-year bonds dated July 1,2016,at 100 1/2 when the market rate of interest was 8%.Cargo Corporation uses the effective-interest method of amortization.Interest is paid each June 30 and December 31.The entry to record the first semi-annual interest payment on December 31,2016,will include a:

Question

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Under the effective-interest method, the interest expense is calculated as a percentage of the carrying amount of the bonds for the period. Given that the bonds were issued at 100 1/2 or 100.50, the carrying amount of the bonds is higher than their face value. This means that a premium exists, which needs to be amortized over the life of the bonds.

The premium on bonds payable is calculated as the difference between the proceeds received from the sale of the bonds and their face value. In this case, the proceeds are $4,000,000 x 100.5% = $4,020,000. The face value is $4,000,000.

Premium on bonds payable = $4,020,000 - $4,000,000 = $20,000.

Since the bonds pay interest semi-annually, the interest expense for the period from July 1, 2016, to December 31, 2016, is calculated as:

Interest expense = Carrying amount of bonds x Market rate x Time
               = $4,020,000 x 8% x 6/12
               = $160,800

Therefore, the entry to record the first semi-annual interest payment on December 31, 2016, will include a debit to Interest Expense for $160,800 and a credit to Interest Payable for $160,800. The premium on bonds payable will be amortized over the life of the bonds, but it will not impact the entry to record the interest payment.

On July 1,2016,Cargo Corporation Issues $4,000,000 of 10-Year Bonds Dated