Question

At the start of the year, Axon, Inc. issued bonds for $38,800. The bonds had a face value of $36,000. If the coupon rate of interest was 9% and the effective (market) rate of interest was 6.73%, how would Axon calculate the interest expense for the first year using the effective interest method?

Answer 1

Interest expense for the first year using the effective interest method = $2,611.24.4

Step-by-step explanation:

the bond issue has a contract rate(coupon rate) of 9%, but the effective rate on the issue was 6.73%

Axon, starts the year with bonds with a carying value equal to $38,800 as the issue sold at a premium. Interest expense should be calculated in such a way that Axon is able to amortise the premium on the bonds over the remaining years to maturity.

In the 1st year, interest expense = effective rate of interest * carrying value of the bonds at the beginning of the year = [tex]0.0673*38,800=2,611.24[tex]

The different between the cash amount that will be paid as coupons i.e 0.09*36,000 =$3,240 and the interest expense to be recorded in the books in the 1st year of $2,611.24 is the amount used to amortise the premium on the bonds in the first year.