Question

On January 1, a company issued 3%, 20-year bonds with a face amount of $80 million for $69,033,776 to yield 4%. Interest is paid semiannually. What was the interest expense at the effective interest rate on the December 31 annual income statement?

Answer 1

Answer:

The interest expense at the effective rate of interest to be recorded in the annual income statement on December 31 is $1,384,289.

Explanation:

We first must know about the long-term debt:

Step 1:

Long term debt:

• It is the borrowing made by the entity to finance the business.
• Includes long-term debentures, and long-term loans.
• Requires to pay the interest, when the tenure of borrowings exceeds one year.

Step 2:

Bond issuance:

Face amount on bonds = $80,000,000

Coupon rate = 3%

Maturity period of the bonds = 20 years

Bond price = $69,033,776

Market rate on bonds with similar risk and maturity = 4%

Interest is paid on bonds semi-annually

* Since the bonds are issued at $69,033,776 on bonds with face amount of $80,000,000, it is understood that bonds are issued at discount.

Step 3:

Calculate semi-annual interest on bonds issued at market rate:

Outstanding balance × effective rate

$69,033,776 × 3%×6/12 = $1,380,675.

Amortization schedule is attached:

Difference between interest paid and effective interest is the amortization of the discount.

The interest expense at the effective rate of interest to be recorded in the annual income statement on December 31 is $1,384,289.