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Ferrone Company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2017. Interest is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. Ferrone uses effective-interest amortization. What amount of interest expense will Ferrone record for the June 30, 2017 payment?

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danialamin

Answer:

The interest expense is recorded at $392,083.

Explanation:

  1. The Bond is issued at a discounted price of $9,802,072
  2. The coupon interest on Bond is 7.8% p.a or 3.90% for 6 month period as the interest is calculated semi-annually
  3. It means that the interest paid every 6 months is $10,000,000*3.90% = $390,000
  4. However Interest expense will be recorded at the market interest rate on the issue price
  5. Here the market interest rate is 8% p.a or 4% for 6 month on the issue price of $9,802,072
  6. So the Interest for 1st payment on June 30th 2017 is $9,802,072*4% = $392,083

Note: After the 1st payment the Bond interest expense will be calculated on the closing value of Bond payable which will be calculated after amortizing the discount of $197,928(10,000,000-9,802,072)

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