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20 July, 16:22

On June 30, 2018, L. N. Bean issued $10 million of its 8% bonds for $9 million. The bonds were priced to yield 10%. Interest is payable semiannually on December 31 and July 1. If the effective interest method is used, how much bond interest expense should the company report for the 6 months ended December 31, 2018? A. $400,000B. $420,000C. $450,000D. $500,000

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  1. 20 July, 16:26
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    The answer is: $450,000

    Explanation:

    The effective interest method is used for bonds sold at a discount. The amount of the bond discount is amortized to interest expense over the bond's life.

    Total annual interest: $800,000 ($10 million x 8%)

    Bond discount: $1 million amortized in 10 years, $100,000 per year (the discount is the difference between bond's par value and selling value $10M - $9M = $1M)

    Total annual interest = $8,000,000 + $100,000 = $900,000

    interest expense for 6 months = $900,000 / 2 = $450,000
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