Amortize Discount by Interest Method

On the first day of its fiscal year, Ebert Company issued $21,000,000 of 5-year, 10% bonds to finance its operations. Interest is payable semiannually. The bonds were issued at a market (effective) interest rate of 12%, resulting in Ebert receiving cash of $19,454,495. The company uses the interest method.

a. Journalize the entries to record the following:

1. Sale of the bonds. Round to the nearest dollar. If an amount box does not require an entry, leave it blank.

2. First semiannual interest payment, including amortization of discount. Round to the nearest dollar. If an amount box does not require an entry, leave it blank.

3. Second semiannual interest payment, including amortization of discount. Round to the nearest dollar. If an amount box does not require an entry, leave it blank.

b. Compute the amount of the bond interest expense for the first year. Round to the nearest dollar.

Annual interest paid$

Discount amortized

Interest expense for first year$

c. Explain why the company was able to issue the bonds for only $19,454,495 rather than for the face amount of $21,000,000.

The bonds sell for less than their face amount because the market rate of interest is the contract rate of interest. Investors willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).