Question

A company prepared the following journal entry:

Dr: Interest expense 10,000
Cr: Discount on bonds payable 2,000
Cr: Cash 8,000
Which of the following statements correctly describes the effect of this journal entry on the financial statements?
A. The bonds payable book value increases by $8,000.
B. CFFF decreases by $2,000.
C. The bonds payable book value decreases by $2,000.
D. CFFO decreases by $8,000.

Answer 1

D. CFFO decreases by $8,000.

Step-by-step explanation:

First and foremost, the amortization of discount on bonds payable would increase the book value of the bond by $2,000 since discount amortized is added to book value while premium amortized is deducted.

As a result, option A which stated that bonds payable book value increases by $8000 is wrong as well as option C since a discount amortization increases bonds payable book value and not the way around.

Cash account with a credit of $8,000 showed that the cash paid to bondholders was $8,000, hence, cash flows from operations (CFFO) should decrease by $8,000