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On january 1, the corporation issued $2,000,000, 10 year, 8% bonds at $2,058,000 with interest payable semi-annually on july 1 and january 1. the effective interest rate is 7%. using the effective interest method of amortization, which of the following debits and credits would the first interest payment include on july 1?

group of answer choices
A. debit premium on bond payable for $7,970 and debit bond interest expense for $72,030.
B. credit cash for $70,000 and credit premium on bonds payable for $10,000.
C. credit cash for $70,000.
D. debit premium on bonds payable for $10,000 and debit bond interest expense for $70,000.

1 Answer

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The first interest payment on July 1 includes a debit to premium on bonds payable for the amortized amount of $10,000 and a debit to bond interest expense for the interest cost of $70,000. This reflects the appropriate recognition of interest expense and the amortization of the bond premium in accordance with the effective interest method.

Debit premium on bonds payable for $10,000: The bond was issued at a premium of $58,000 ($2,058,000 - $2,000,000). The premium needs to be amortized over the life of the bond using the effective interest method. For the first interest payment, a portion of the premium is amortized, which is calculated as the effective interest rate (7%) multiplied by the beginning carrying amount of the bonds. In this case, it is $2,058,000 * 7% = $144,060 for the full year. Since interest is paid semi-annually, the first interest payment would be $144,060 / 2 = $72,030. Therefore, the premium on bonds payable is debited by the amortized amount.

Debit bond interest expense for $70,000: The total cash interest payment for the first semi-annual period is $2,000,000 * 8% * 6/12 = $80,000. However, the interest expense recognized on the income statement is based on the effective interest rate, which is 7%. Therefore, the bond interest expense is calculated as $2,058,000 * 7% = $144,060 for the full year, and for the first semi-annual period, it is $144,060 / 2 = $72,030. This amount needs to be recognized as an expense on the income statement.

The correct answer is D. Debit premium on bonds payable for $10,000 and debit bond interest expense for $70,000.

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