Final answer:
Neglecting to amortize the premium on bonds payable results in overstated interest expense and bond carrying value. The bond premium must be amortized over the life of the bonds, which decreases interest expense and carrying value to the bond's face value at maturity.
Step-by-step explanation:
If Kenwood Co. neglects to amortize the premium on its outstanding ten-year bonds payable, it will affect the interest expense and bond carrying value over time. When a company issues bonds at a premium, it means the bonds sell for more than their face value. This premium must be amortized over the life of the bonds, which effectively reduces the bond's book value to its face value by the time the bonds mature. The amortization of the bond premium is accounted for as an expense, which decreases the amount of interest expense reported on the income statement each period.
If the premium is not amortized, the interest expense reported will be incorrectly high since the decrease due to amortization is not being realized. Additionally, the carrying value of the bonds on the balance sheet will be overstated, as it should decrease over time due to the premium amortization.
For example, suppose Ford Motor Company issues a five-year bond with a face value of $5,000 that pays an annual coupon payment of $150. The implied interest rate is 3% ($150/$5000). If market interest rates rise from 3% to 4%, the value of the bond will decrease because newer bonds pay a higher interest rate, making the older, lower-interest bonds less attractive.
Similarly, imagine a local water company issued a $10,000 ten-year bond at 6%. If interest rates rise to 9% one year before maturity, you would expect to pay less than $10,000 for the bond because its fixed interest payments are less favorable compared to the new market rate. The actual price would be calculated based on the present value of the bond's remaining cash flows discounted at the new market rate of 9%.