Question

Jacobs Company issued bonds with $158,000 face value on January 1, Year 1. The bonds were issued at 105 and carried a 5-year term to maturity. They had a 8% stated rate of interest that was payable in cash on December 31st of each year. Jacobs uses the straight-line method of amortization. Based on this information alone, the recognition of interest expense on December 31, Year 1 would act to:

a. Decrease both assets and stockholders’ equity by $11,060.

b. Decrease stockholders’ equity by $11,060, decrease liabilities by $1,580, and decrease assets by $12,640.

c. Increase liabilities by $1,580, decrease assets by $11,060, and decrease stockholders’ equity by $12,640.

d. Decrease both assets and stockholders’ equity by $12,640.

Answer 1

Answer b) Decrease stockholders Equity by $11,060 decrease Liability by $1,580 and decrease assets by $12,640

- stockholders Equity would be reduced by $11,060 which is ($158,000 × 8%) - ($7,900/5) = $11,060. Interest expense willl be reduced by $,1580 each year which is Amortization of Premium.

- Assets would be reduced by $12,060 since company will pay interest of $12,060 which is ( $158,000×8%) = $12,640

- Since Company has received premium of $7,900 ($158,000/100 × 105). It will be amortized by $1,580 ($7,900/5) every year which will reduce the total premium by $1,580 each year.