A company issued 5-year, 7% bonds with a par value of $100,000. The market rate when the bonds were issued was 6.5%. The company received $102,105 cash for the bonds.
-Using the effective interest method, the amount of recorded interest expense for the first semiannual interest period is:
A) $7,000.00.
B) $1,750.00.
C) $3,318.41.
D) $6,573.90.
E) $3,500.00.

Question

A company issued 5-year, 7% bonds with a par value of $100,000. The market rate when the bonds were issued was 6.5%. The company received $102,105 cash for the bonds. 
-Using the effective interest method, the amount of recorded interest expense for the first semiannual interest period is:
A) $7,000.00.
B) $1,750.00.
C) $3,318.41.
D) $6,573.90.
E) $3,500.00.

Quizplus · Accepted Answer

First, we need to calculate the effective interest rate using the market rate and the price paid for the bond:
Effective interest rate = (1 + Market rate/2)^2 - 1
Effective interest rate = (1 + 0.065/2)^2 - 1
Effective interest rate = 0.06641625 or 6.641625%

Next, we can use the effective interest rate to calculate the interest expense for the first semiannual period:
Interest expense = carrying value of bond at beginning of period x effective interest rate
Carrying value of bond at beginning of period = price paid for bond - amortization of discount
Amortization of discount = (Par value - price paid)/number of periods
Amortization of discount = ($100,000 - $102,105)/10
Amortization of discount = $-2,105
Carrying value of bond at beginning of period = $102,105 - $2,105 = $100,000
Interest expense = $100,000 x 0.06641625 = $3,318.41

Therefore, the amount of recorded interest expense for the first semiannual interest period is $3,318.41.

A Company Issued 5-Year, 7% Bonds with a Par Value