Question

On January 1 of Year 1, Congo Express Airways issued $2,500,000 of 5% bonds that pay interest semiannually on January 1 and July 1. The bond issue price is $2,260,000 and the market rate of interest for similar bonds is 6%. The bond premium or discount is being amortized at a rate of $8,000 every six months. After accruing interest at year end, the company's December 31, Year 1 balance sheet should reflect total liabilities associated with the bond issue in the amount of:

a. $2,276,000

b. $2,213,500

c. $2,786,500

d. $2,724,000

e. $2,338,500

Answer 1

*Calculation of Amount of Bond Discount:

The bond premium is $8000 for six months. The bond premium will be doubled for a year which appears as $16000 ($8000*2) since the bond is paid on semi-annual or on six month basis.

Amount of bond discount= [(Face value - issue price) - Bond premium or discount]

=[(2500000 - 2260000)-16000] = $224000

*Book value of Bond = [Face value - Amount of Bond discount] = [2500000 - 224000] = $2276000

*Interest payable = Face value X coupon rate = $2500000 X 5% X 6 months / 12 months = $62500

Total liabilities associated with bond issue= Book value + Interest Payable= $ 2276000 + $ 62500 =$ 2338500

Option (e) is Correct.