Question

Amortize Discount by Interest Method

On the first day of its fiscal year, Ebert Company issued $18,000,000 of 5-year, 10% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 11%, resulting in Ebert Company receiving cash of $17,321,607. The company uses the interest method.

a. Journalize the entries to record the following:

1. Sale of the bonds. Round amounts to the nearest dollar. For a compound transaction, if an amount box does not require an entry, leave it blank.

	Cash
	Discount on Bonds Payable
	Bonds Payable

2. First semiannual interest payment, including amortization of discount. Round to the nearest dollar. For a compound transaction, if an amount box does not require an entry, leave it blank.

	Interest Expense
	Discount on Bonds Payable
	Cash

3. Second semiannual interest payment, including amortization of discount. Round to the nearest dollar. For a compound transaction, if an amount box does not require an entry, leave it blank.

	Interest Expense
	Discount on Bonds Payable
	Cash

b. Compute the amount of the bond interest expense for the first year. Round amounts to the nearest dollar.

Annual interest paid	$
Discount amortized
Interest expense for first year	$

c. Explain why the company was able to issue the bonds for only $17,321,607 rather than for the face amount of $18,000,000.

The bonds sell for less than their face amount because the market rate of interest is greater than/less than/equal the contract rate of interest. Investors are not/are willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).

Answer 1

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