Question

On January 1, 2018, Bentley Corporation issued $1,000,000 of 10-year, 8% bonds at 105, when the market rate of interest was 7%. The bonds pay interest annually on December 31. The company uses the effective interest method of amortization. How much interest expense will Bentley Corporation report on its income statement for the year ended December 31, 2018?

Answer 1

The interest expense for Bentley Corporation for the year ended December 31, 2018, calculated using the effective interest method is $73,500. This figure is derived from multiplying the beginning carrying amount by the market rate of interest, not the coupon rate.

Step-by-step explanation:

To calculate the interest expense that Bentley Corporation will report on its income statement for the year ended December 31, 2018, using the effective interest method of amortization, we follow these steps:

1. Determine the carrying amount of the bonds at the beginning of the period, which in this case is the issuance price: $1,000,000 * 105% = $1,050,000.
2. Calculate the effective interest expense for the period based on the market rate of interest at issuance, not the coupon rate. In this case, we use the market rate of 7%: $1,050,000 * 7% = $73,500.
3. Since the bonds pay interest annually at the coupon rate (8% of the face value) on December 31, we find the annual coupon payment: $1,000,000 * 8% = $80,000.
4. Next, we calculate the amortization of the bond premium by subtracting the effective interest expense from the annual coupon payment: $80,000 - $73,500 = $6,500.
5. To find the new carrying amount of the bonds at the end of the period, we subtract the amortization from the initial carrying amount: $1,050,000 - $6,500 = $1,043,500.
6. The interest expense reported on the income statement for the year ended December 31, 2018, is the effective interest expense, which is $73,500.

This is how Bentley Corporation uses the effective interest method of amortization to calculate and report the interest expense on its income statement.

Answer 2

$80,000

Step-by-step explanation:

Given:

Amount issued by the Bentley Corporation = $1,000,000

Duration = 10 years

Interest rate on the bods = 8% annually

Market rate of interest = 7% annually

Now,

the interest charged will at the rate on the bonds i.e 8%,

therefore,

the Interest expenses = Rate × Amount issued

on substituting the respective values, we get

the Interest expenses = 0.08 × $1,000,000

or

the Interest expenses = $80,000