On January 1, 2016, an investor paid $291,000 for bonds with a face amount of $3
ID: 2334432 • Letter: O
Question
On January 1, 2016, an investor paid $291,000 for bonds with a face amount of $300,000. The state rate of interest is 8% while the current market rate of interest is 10%. Using th eeffective interest method, how much interest income is recognized by the investor in 2016 (assume annual interest payments and amortization)? HINT: Interest income to the investor is the same as interest expense to the debtor. A. $23,280 B. $29,100 C. $24,000 D. $30,000 Is this a premium or a discount? What is the carrying value at the end of year 1 (line 1 on the schedule)? What is the carrying value just before the bonds are paid off? Would you use straight line amortization? Why or why not? What is the cash interest paid each period? What is the interest expense in year 1 (line 1 on the schedule)? What is the interest expense journal entry for year 1?
Explanation / Answer
1) Interest income to the investor = 291000*10% = $ 29,100 Answer: Option [B] 2) It is a discount. 3) Carrying value at the end of year 1: Face value of the bonds $ 3,00,000 Less: Unamortized discount = 9000-(29100-24000) = $ 3,900 Carrying value at the end of year 1 $ 2,96,100 4) Carrying value just before the bonds are paid off $ 3,00,000 5) No. Straight line does not reflect the interest expense correctly. 6) Cash interest paid each year = 300000*8% = $ 24,000 7) Interest expense for Year 1 (for the issuer) $ 29,100 8) Journal entry (for the issuer): Interest expense $ 29,100 Discount on bonds payable 5100 Cash 24000