Cramer Company sold five-year, 8% bonds on October 1, 2013. The face amount of the bonds was $100,000, while the issue price was $102,000. Interest is payable on April 1 of each year. The fiscal year of Cramer Company ends on December 31. How much interest expense will Cramer Company report in its December 31, 2013, income statement (assume straight-line amortization)?

Question

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The total interest to be paid over the life of the bond is $40,000 (8% of $100,000 for five years). The premium paid over the face amount is $2,000 ($102,000 - $100,000). To amortize the premium over the life of the bond, the annual amortization is $400 ($2,000/5 years). Therefore, the interest expense for the first year is the cash interest paid of $8,000 ($100,000 x 8%) plus the amortization of the premium of $400, which equals $8,400. However, since interest is only paid twice during the fiscal year (April 1 and October 1), only half of the interest expense should be recognized for the fiscal year ended December 31, 2013. Thus, the interest expense reported in the income statement for the year ended December 31, 2013, is $4,200 ($8,400/2), which is closest to option B ($1,900).

Cramer Company Sold Five-Year, 8% Bonds on October 1, 2013