[NewStudentJA]

here is the problem Exercise 10-2 Straight-line amortization of bond discount L.O. P2

Sears issues bonds with a par value of $175,000 on January 1, 2009. The bonds' annual contract rate is 4%, and interest is paid semiannually on June 30 and December 31. The bonds mature in three years. The annual market rate at the date of issuance is 6%, and the bonds are sold for $165,523.

Required:

1. What is the amount of the discount on these bonds at issuance? (Omit the "$" sign in your response.) That answer was easy it is $9,477. But this next question

2. How much total bond interest expense will be recognized over the life of these bonds?
I'm coming up with 6,620.92 The computer is telling me I'm wrong even when I round up to 6,621. I've also tried following the book step by step and I can't get the right answer. I cant' complete the rest of the problem without it. I also tried calculating 4 % of the non discount price of 175,000 which is 7,000. the computer is telling me its wrong as well.

What am I doing wrong?

[morgaine300]

I don't know where you got the 6621 so I'm not sure what you're trying to do.

You have to understand what "expense" means in this context. The payment per year will be $7000. (It will actually be recorded on a semi-annual basis, but we can use annual for this purpose.)

The discount per year is 3159. (9477/3)

The discount is a contra liability, i.e. a debit account. (Reduces the carrying value of the bond.) When you amortize the discount, you have to reverse that out, that is, credit that discount account. The other side of that entry, the debit, is interest expense. It's a little complicated to understand why the discount is treated as extra interest expense. But you do need to know that entry for class.

Notice the amortized discount is added to interest expense. So in addition to the $7000 of interest payment that's charged to interest expense, you also have that discount charged to it. So the expense per year is $10,159. Times 3 years for the total expense over the life of the bonds.

That amount should, in theory, equal 6% interest for 3 years total. Charging off the discount to the expense ends up being the equivalent of actually paying the market. Except it doesn't equal, but it's close.

As a note, premium amortizations will reduce the interest expense, the opposite.

[NewStudentJA]

Thanks. We went over this in class, but this does help.