On January 1,2013,$1,200,000,5-year,bonds with a stated rate of 10% payable annually were issued for cash of $1,295,844 when the market rate of interest was 8%.The first annual cash interest payment was $120,000 while that period's interest expense was calculated as $103,666.How would the company record the journal entry to record this first annual interest payment?
A)Debit Interest Expense for $103,666,debit Premium on Bonds Payable for $16,334,and credit Cash for $120,000.
B)Debit Interest Expense for $120,000 and credit Cash for $120,000.
C)Debit Interest Expense for $16,334 and credit Cash for $16,334.
D)Debit Interest Expense for $120,000,credit Discount on Bonds Payable for $16,334,and credit Cash for $103,666.
E)Debit Cash for $1,295,844,credit Premium on Bonds Payable for $1,200,000,and credit Premium on Bonds Payable for $95,844.

Question

Quizplus · Accepted Answer

The company issued bonds at a premium (issued at a higher price than their face value) because the stated rate of interest was higher than the market rate of interest. Therefore, the company recorded a debit to Premium on Bonds Payable for the excess of the cash received over the face value of the bonds. The interest payment for the first year is based on the face value of the bonds ($1,200,000 x 10% = $120,000). However, the interest expense recorded in the books is based on the market rate of interest at the time of issuance, which is 8%. Therefore, the interest expense is lower than the interest payment ($1,200,000 x 8% = $96,000). The difference between the interest payment and the interest expense is recorded as a reduction of the premium on bonds payable (Premium on Bonds Payable - reduction = $16,334). The entry to record the first annual interest payment is: Debit Interest Expense for $103,666, debit Premium on Bonds Payable for $16,334, and credit Cash for $120,000.

On January 1,2013,$1,200,000,5-Year,bonds with a Stated Rate of 10% Payable