On July 1, 2020, the Jazz Corporation issues $4,000,000 of 10-year bonds dated July 1, 2020, at 89 when the market rate of interest was 8%. Jazz Corporation uses the effective-interest method of amortization. Interest is paid each June 30 and December 31. The entry to record the first semi-annual interest payment on December 31, 2020, will include a:
A) credit to Discount on Bonds Payable for $284,800
B) debit to Premium on Bonds Payable for $160,000
C) credit to Interest Payable for $320,000
D) debit to Interest Expense for $142,400

Question

Quizplus · Accepted Answer

The first semi-annual interest payment represents six months' interest on the bond. The bond is issued at a discount, which means that the effective interest rate will be greater than the stated rate of 8%. The calculation of the effective interest rate is as follows:

PV = $4,000,000 x 0.89 = $3,560,000 (present value of the bond)
FV = $4,000,000 (face value of the bond)
n = 20 (number of semi-annual periods)
i = ? (effective interest rate)

Using the formula for the present value of an annuity, we can solve for i:

PV = (C/i) x [1 - (1/(1+i)^n)]
$3,560,000 = (C/i) x [1 - (1/1.04^20)]
$3,560,000 = (C/i) x 9.8161
C/i = $362,718.09

The semi-annual interest payment is $362,718.09, which is 9.08% of the face value of the bond ($4,000,000 x 0.08 x 0.5 = $160,000). The difference between the semi-annual interest payment and the coupon payment of $160,000 represents the amortization of the discount. Therefore, the entry to record the first semi-annual interest payment on December 31, 2020, will be:

Debit Interest Expense for $142,400 ($362,718.09 - $160,000)
Credit Cash for $320,000 ($4,000,000 x 0.08 x 0.5)
Credit Discount on Bonds Payable for $178,400 ($142,400 + $36,000)

On July 1, 2020, the Jazz Corporation Issues $4,000,000 of 10-Year