Activation Exercise 12-2: Straight Line Bond Discount Amortization

Terms and Definitions

When a bond sells for less than its face amount, the difference between the selling price and the face amount is called a . A bond discount or premium must be amortized to interest expense . The straight line method amortizes equal amounts of bond discount or premium to interest expense each period. Amortization of a bond discount the contract rate of interest to a rate of interest that approximates the market rate of interest.

Understanding the Business Transaction

Bonds sell at a discount when the market rate of interest is the contract rate of interest. Discount amortization is the amount of cash interest paid, causing the amount of interest expense reported on the income statement to be the amount of semi-annual cash interest paid on a bond.

On January 1, 2014, Jack Company issues $4,105,000, 6%, 10-year bonds for cash of $3,304,025 when the market rate of interest is 9%. The bonds pay interest semi-annually on June 30 and December 31. Determine (1) the discount on bonds payable at the date of issuance, (2) the semi-annual cash interest payment, (3) the semi-annual discount amortization using the straight line method, and (4) the semi-annual interest expense.

Round your answers to the nearest whole dollar amount.

Selling Price of Bonds		$
Face Value of Bonds
Discount on Bonds Payable		$
Cash interest payment		$
Discount amortization
Interest expense		$

Recording in the Accounting System

Journalize the first interest payment and the amortization of the bond discount on June 30, 2014.

Round your answers to the nearest whole dollar amount. If an amount box does not require an entry, leave it blank.

When bonds sell at a discount, the semi-annual interest expense reported in the income statement will be the semi-annual cash interest paid to bondholders.

Financial Statement Impact

On July 1, 2014 Botwin Company issues $1,000,000, 10%, bonds payable. Click here and use the sliders provided for the market rate of interest and the number of semi-annual periods to answer the following questions.

1.	If the bonds have a 10-year term and are issued when the market rate of interest is 12%:

a.	How much semi-annual interest expense will the company report every six months?
	$

b.	How much of the bond discount will the company amortize every six months?
	$

c.	How much cash interest will the company pay to bondholders every six months?
	$

d.	If the market rate of interest remains constant, and the number of periods decreases, the semi-annual discount amortization will .

2.	If the bonds have a 5-year term and are issued when the market rate of interest is 14%:

a.	How much semi-annual interest expense will the company report every six months?
	$

b.	How much of the bond discount will the company amortize every six months?
	$

c.	How much cash interest will the company pay to bondholders every six months?
	$

d.	If the number of periods remains constant, and the market rate of interest increases, the semi-annual interest expense will .