Question

on january 1, year one, a zero-coupon bond with a face value of $12 million is issued for $7.8 million to create an effective annual interest rate of 9 percent. the bond will be paid in exactly five years. if the effective rate method is applied, what liability balance is reported on december 31, year one?

Answer 1

The liability balance reported on December 31, year one, is $11,008,800.

Step-by-step explanation:

The liability balance reported on December 31, year one, can be calculated using the present value formula. The present value of a zero-coupon bond is equal to the face value multiplied by the discount factor. In this case, the face value of the bond is $12 million and the discount factor can be calculated using the formula:

Discount Factor = 1 / (1 + interest rate)number of years

On December 31, year one, the bond has been in existence for one year. Therefore, the discount factor would be:

Discount Factor = 1 / (1 + 0.09)1 = 0.9174

The liability balance reported on December 31, year one, can be calculated as:

Liability Balance = Face Value * Discount Factor

Liability Balance = $12 million * 0.9174

Liability Balance = $11,008,800