Question

On July 1, 2016, Overlin Corp. purchased $100,000 of 8% bonds at face value. Interest is paid annually on June 30. If the accounting year for Overlin ends at December 31, 2016, what will be reported with respect to the bonds on that date?

a. Interest income in the amount of $4,000 will be accrued.
b. A loss on the bonds will be reported in the Other Income and Expense section of the 2016 income statement until the entire amount of interest is paid on June 30, 2017.
c. The cash received in interest will be $8,000.
d. The carrying value of the bonds will be $108,000.

Answer 1

The interest income in the amount of $4,000 will be accrued on December 31, 2016 with respect to the bonds.

Step-by-step explanation:

The correct answer is option a. Interest income in the amount of $4,000 will be accrued.

Since Overlin Corp. purchased the bonds on July 1, 2016, and the accounting year ends on December 31, 2016, only half a year's worth of interest income will be accrued. The interest on the bonds is paid annually on June 30. Therefore, from July 1, 2016, to December 31, 2016, six months have passed and half of the annual interest of 8% will be earned. The face value of the bonds is $100,000, so the interest income for the period is calculated as follows: $100,000 * 8% * 6/12 = $4,000.