On January 1, 2013, 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 2014 (assume annual interest payments and amortization)?

Question

Quizplus · Accepted Answer

Under the effective interest method, interest income is calculated by multiplying the carrying value of the bonds (beginning balance plus amortization) by the effective interest rate.
Effective interest rate = (face amount - purchase price) / carrying value
Effective interest rate = ($300,000 - $291,000) / $291,000
Effective interest rate = 3.09%
Interest income for 2014 = carrying value at beginning of year x effective interest rate
Carrying value at beginning of year = face amount - unamortized discount
Carrying value at beginning of year = $300,000 - ($9,000 / 2) = $295,500
Interest income for 2014 = $295,500 x 3.09% = $9,110
Since the annual interest payments are not given, we do not need to consider them for this calculation.
Therefore, the correct option is D.

On January 1, 2013, an Investor Paid $291,000 for Bonds