Final answer:
The statement regarding the effective interest method is false. This method uses the market rate of interest to calculate interest expense based on the bond's carrying value. To find a bond's present value, future payments are discounted at the market rate.
Step-by-step explanation:
The effective interest method does not calculate interest expense by multiplying the carrying value of the bonds by the stated rate of interest. The correct statement is false. Instead, the effective interest method calculates interest expense on a bond by using the market rate of interest (also known as the effective rate or yield) at the time of issuance to determine interest payments, based on the bond's carrying value at the start of the accounting period.
For example, consider a simple two-year bond issued at $3,000 with a stated interest rate of 8%. This bond would pay $240 in interest each year (which is $3,000 × 8%). To determine what this bond is worth in the present if the market discount rate is 8%, and then again at 11%, we use the present value formula. By discounting the future payments (interest and the principal) at the respective rates, we can calculate the present value of the bond. This represents the price of the bond based on the stream of future expected payments.Real-world calculations can be more sophisticated, as they may also consider the credit risk associated with the borrower and any changes in market interest rates that may occur over the lifespan of the bond.