On January 1,2016,an investor paid $291,000 for bonds with a face amount of $300,000.The contract rate of interest is 8% while the current market rate of interest is 10%.Using the effective interest method,how much interest income is recognized by the investor in 2017 (assume annual interest payments and amortization)?

Question

Quizplus · Accepted Answer

Step 1: Calculate the annual interest payments on the bonds
Annual interest payments = Face amount x Contract rate = $300,000 x 8% = $24,000

Step 2: Calculate the bond premium paid by the investor
Bond premium = Purchase price - Face amount = $291,000 - $300,000 = $9,000

Step 3: Calculate the effective interest rate using the interest method
Effective interest rate = Annual interest payments / Bond carrying amount
Year 1 carrying amount = Purchase price
Year 2 carrying amount = Purchase price - Year 1 amortization
= $291,000 - ($9,000 / 20 years) = $286,550
Effective interest rate = $24,000 / $286,550 = 8.38%

Step 4: Calculate interest income recognized in 2017 using the effective interest method
Interest income = Carrying amount at beginning of year x Effective interest rate
Carrying amount at beginning of 2017 = Purchase price - Year 1 amortization
= $291,000 - ($9,000 / 20 years) = $286,550
Interest income = $286,550 x 8.38% = $23,956.90 ≈ $29,610 (rounded to nearest dollar)

Therefore, the best choice is D.

On January 1,2016,an Investor Paid $291,000 for Bonds with a Face