Question

Seaside Corp. issued 10%, 5-year bonds with a face amount of $50,000 on January 1, 2020. The market interest rate for bonds of similar risk and maturity is 12%. Interest is paid semiannually on June 30 and December 31. Seaside uses the effective interest method to account for these bonds. For these bonds, the carrying value would

Group of answer choices

Increase each period from issue date to maturity date

Stay the same and neither increase nor decrease from issue date to maturity date

Cannot be determined from the given information

Decrease each period from issue date to maturity date

Answer 1

Answer is 1st option i.e. the carrying value would

Increase each period from issue date to maturity date.

Explanation

Effective interest method is one of the easiest and most common methods for computation of carrying value.

In the question, market rate of interest = 12%, which is more than the coupon rate, i.e. 10%. Therefore, bond shall be sold at a discount. Thus, its carrying value shall be less than its face value of $50000.

Carrying value of bond means the face value less unamortized discount.

Under effective interest method, if the bond's book value increases , the amount of interest expense will increase.