Question

Judie Co. issued bonds with a contract interest rate of 0% and a face amount of $100,000. These are zero-contract interest bonds (i.e., no payments are made except for the lump sum payment of the face value of the bonds on their maturity date). The bonds mature in 20 years. The market interest rate for bonds with the same degree of riskiness is 4% compounded annually. These bonds were issued on January 1 of Year 1. Jude uses the effective-interest method on its books. Note: Round all your calculations to the nearest dollar. In the journal entry made in connection with these bonds on December 31 of Year 1, there is a

	A.	DEBIT to Interest Expense of $4,000
	B.	DEBIT to Discount on Bonds of $4,000
	C.	DEBIT to Discount on Bonds of $1,824
	D.	DEBIT to Interest Expense of $1,824

Answer 1

Answer: Option D.DEBIT to Interest Expense of $1,824

Working:

Par value of bonds = $100,000

Effective interest rate (i) = 4%

Time period (n)= 20 years

Issue price of bonds = Par value of bonds x Present value factor (i%,n)

= 100,000 x Present value factor (4%,20)

= 100,000 x 0.456

= $45,600

The journal entry at issue date will be:

General Journal	Debit	Credit
Cash	$45,600
Discount on bonds payable	$54,400
Bonds payable		$100,000

Interest expense at December 31, Year 1 will be = Issue price of bonds x Effective interest rate

= 45,600 x 4%

= $1,824

Hence, at December 31, Year 1, interest expense will be debited and discount on bonds payable will be credited by $1,824