Question

On June 30, 2020, Kingbird Company issued $3,120,000 face value of 15%, 20-year bonds at $3,824,160, a yield of 12%. Kingbird uses the effective-interest method to amortize bond premium or discount. The bonds pay semiannual interest on June 30 and December 31.

Provide the answers to the following questions.

(1) What amount of interest expense is reported for 2021? (Round answer to 0 decimal places)

(2) Will the bond interest expense reported in 2021 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used?

(3) Determine the total cost of borrowing over the life of the bond. (Round answer to 0 decimal places)

(4) Will the total bond interest expense for the life of the bond be greater than, the same as, or less than the total interest expense if the straight-line method of amortization were used?

Answer 1

1.

Calculate interest income reported for 2021 as follows:

	A	B	C	D	E
1	Date	Interest paid	Interest expense	Premium amortized	Carrying value
2	Jun. 30, 2020				3824160
3	Dec. 31, 2020	234000	229450	4550	3819610
4	Jun. 30, 2021	234000	229177	4823	3814786
5	Dec. 31, 2021	234000	228887	5113	3809673
6
7	Interest expense reported for 2021			458064

Therefore, interest expense reported for 2021 is $458,064.

Above figures have been calculated in the following manner:

	A	B	C	D	E
1	Date	Interest paid	Interest expense	Premium amortized	Carrying value
2	Jun. 30, 2020				3824160
3	Dec. 31, 2020	=3120000*15%*(1/2)	=E2*12%*(1/2)	=B3-C3	=E2-D3
4	Jun. 30, 2021	=3120000*15%*(1/2)	=E3*12%*(1/2)	=B4-C4	=E3-D4
5	Dec. 31, 2021	=3120000*15%*(1/2)	=E4*12%*(1/2)	=B5-C5	=E4-D5
6
7	Interest expense reported for 2021			=C4+C5

2.

Interest expense reported for 2021 under the effective interest method = $458,064

Premium on bonds payable recorded at the time of issue of the bonds = $3,824,160 - $3,120,000 = $704,160

Premium amortized annually under the straight-line method = $704,160/20 = $35,208

Therefore,

Interest expense reported for 2021 under straight-line method = ($3,120,000 x 15%) - $35,208 = $432,792

Thus,

Bond interest expense reported in 2021 will be greater than the amount that would be reported if the straight-line method of amortization were used.

3.

Total cost of borrowing over the life of the bond

= Total interest paid - Premium received on issue of bonds

= ($3,120,000 x 15% x 20) - $704,160

= $8,655,840

4.

The total bond interest expense for the life of the bond will be the same as the total interest expense if the straight-line method of amortization were used.