Question

Milky Company's 5%, $100,000 face amount bonds have a carrying value of $98,000. When the bonds were issued two years ago, the effective interest rate was 6%. The bonds pay interest semi-annually on April 1 and October 1. In the December 31 adjusting entry, Milky Company should recognize interest expense of

Multiple choice question.
a) $3,000
b) $5,000
c) $6,000
d) $4,000
e) $2,000

Answer 1

In the December 31 adjusting entry, Milky Company should recognize interest expense of $3,000.

Step-by-step explanation:

In the December 31 adjusting entry, Milky Company should recognize interest expense of $3,000.

The interest expense is calculated using the effective interest rate, which was 6% when the bonds were issued two years ago. The carrying value of the bonds is $98,000, which is $2,000 less than the face amount of $100,000. Therefore, the interest expense is $2,000 × 6% = $<<2000*6*.01=120>>120 for the first six months.

Since the bonds pay interest semi-annually, the total interest expense for the year is $120 × 2 = $240. Therefore, the interest expense in the December 31 adjusting entry is $240 × 2 = $<<240*2=480>>480.