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11 September, 10:58

Cramer Company sold five-year, 8% bonds on October 1, 2018. The face amount of the bonds was $100,000, while the issue price was $102,000. Interest is payable on April 1 of each year. The fiscal year of Cramer Company ends on December 31. How much interest expense will Cramer Company report in its December 31, 2018, income statement (assume straight-line amortization) ?

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  1. 11 September, 11:10
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    Interest expense reported by Cramer is $1900.

    Explanation:

    The interest is due for 3 months.

    Cash interest here will be

    = Face amount of bond x interest rate x (No. of months the interest is due / Total number of months in a year)

    = $100000 x 8% x (3 months / 12 months)

    = $8000 x 3/12

    = $2000

    Now, the amount of premium to be amortized

    = Issued amount of bonds - Face amount of bonds

    = $102000 - $100000

    = $2000

    And, the premium amortization (for 3 months)

    = Amount of premium x (1 / Duration of bonds) x (No. of months / Total number of months in a year)

    = $2000 x (1 year / 5 years) x (3 months / 12 months)

    = $2000 x 1/5 x 3/12

    = $400 x 3/12

    = $100

    So, Interest expense

    = Cash interest - Premium amortization

    = $2000 - $100

    = $1900
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