The adjustment necessary at December 31,Year 1 (if any),related to this bond issue involves:
A)Recognition of interest expense of $3,600,000.
B)Recognition of interest expense of $1,800,000.
C)Payment of cash of $1,800,000.
D)There is no adjustment necessary.

Question

Quizplus · Accepted Answer

Bonds issued at a discount require an adjustment at the end of each accounting period to account for the accretion of the discount. In this case, the bond is issued at a discount of $200,000 ($2,000,000 - $1,800,000). This discount needs to be recognized over the life of the bond as interest expense. The discount amortization for the first year is ($200,000 ÷ 10 years) = $20,000 per year. Therefore, at the end of Year 1, an adjustment is necessary to recognize interest expense of $1,800,000 (coupon rate of 10% x $18,000,000 face value) plus an additional $20,000 for the amortization of the discount. This brings the total interest expense to $1,820,000.

The Adjustment Necessary at December 31,Year 1 (If Any),related to This