Question

ABC Company received $9,631 for its 5-year, 10% bonds with a total face value of $10,000. The market rate of interest was 11%. The bonds pay interest annually on December 31. How much interest expense will ABC Corporation record on the first annual interest payment date using the effective-interest method?A. $1,059
B. $1,000
C. $1,074
D. $963.10

Answer 1

Answer:

The correct answer is Option A.

Explanation:

The effective interest rate (EIR) method is used when a bond is purchased at a discount or premium.

In the case of the question, the bond was purchased at $9,631 with a face value of $10,000. Interest expense is calculated as the bond price multiplied by the market rate, i.e. $9,631  x 11% = $1,059.41.

Therefore, ABC Company would record $1,059 on the first annual interest payment date using the effective-interest method.

Answer 2

Answer:

A. $1,059

Explanation:

Interest payment and interest expense of the bond issued on discount is different. The difference of both of these values is the amortization of discount on the bond, which is added to carrying value of the bond each year to make the carrying value equals to face value at maturity date.

Interest expense using effective interest method is calculated by multiplying the market interest rate to the net carrying value of the bond.

Carrying value of the bond in 1 st year = $9,631

Market Rate = 11%

Interest expense = $9,631 x 11% = $1059.41