Zero Coupon Bonds The U.S. Treasury requires issuers of "deep-discount" or "zero coupon" debt securities to use an effective interest approach to amortization of discount. Similarly, buyers of such securities must record interest income under the effective interest rate method. This law replaced an old tax law that permitted straight-line amortization of bond discount. 1. Assume that Mattel, maker of Barbie Dolls and other toys, issues a 10-year zero coupon bond having a face amount of $20,000,000 to yield 10%. For simplicity, assume that the 10% yield is compounded annually. Prepare the journal entry for the issuer. 2. Prepare the journal entry for interest expense for the first full year and the second full year using

(a) straight-line and

(b) effective interest amortization. 3. Assume an income tax rate of 35%. How much more income tax for the first year would the issuer have to pay because of applying effective interest instead of straight-line amortization? 4. What kinds of borrowers might prefer these investments over bonds that pay interest immediately?