On the first day of the fiscal year, Lisbon Co. issued $1,000,000 of 10-year, 7% bonds for $1,050,000, with interest payable semiannually. Orange Inc. purchased the bonds on the issue date for the issue price. If the company uses the straight-line method for amortizing the premium, the journal entry to record the first semiannual interest payment by Lisbon Co. would include a debit to:
A) Interest Payable for $30,000
B) Interest Expense for $32,500
C) Cash for $70,000
D) Premium on Bonds Payable for $5,500

Question

Quizplus · Accepted Answer

The semiannual interest payment would be $1,000,000 x 7% x 6/12 = $35,000. However, since Lisbon Co. issued the bonds at a premium, they will receive $50,000 ($1,050,000 - $1,000,000) more than the face value of the bonds. This premium will be amortized over the life of the bonds using the straight-line method. The annual amortization amount would be $50,000/10 = $5,000, and the semiannual amount would be $2,500.

Therefore, the journal entry to record the first semiannual interest payment would be:

Debit: Interest Expense $32,500 ($35,000 - $2,500)
Credit: Cash $70,000
Credit: Premium on Bonds Payable $2,500 ($5,000/2)

The answer is B because the debit entry must be made for the Interest Expense, which is calculated as the difference between the semiannual interest payment and the semiannual amortization of the premium.

On the First Day of the Fiscal Year, Lisbon Co