Question

Chang Corporation issued $3,000,000 of 9%, ten-year convertible bonds on July 1, 2010 at 96.1 plus accrued interest. The bonds were dated April 1, 2010 with interest payable April 1 and October 1. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2011, $600,000 of these bonds were converted into 500 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.

If "interest payable" were credited when the bonds were issued, what should be the amount of the debit to "interest expense" on October 1, 2010?


a. $64,500.
b. $67,500.
c. $70,500.
d. $135,000.

Answer 1

The debit to "interest expense" on October 1, 2010, includes both the semiannual interest payment on the bond and the amortization of the bond discount. The total amount is the sum of the semiannual interest payment of $135,000 and the semiannual amortization of the discount of $5,850, resulting in a total debit of $140,850.

Step-by-step explanation:

The student's question pertains to the calculation of interest expense for a bond issued at a discount with semiannual interest payments. Initially, when calculating the interest expense for the period, the amount of interest paid must include the actual interest payment as well as the amortization of the bond discount.

Since the bond was issued at 96.1, there is a discount of 3.9% on the face value of $3,000,000 which equals $117,000. This discount is amortized over the ten-year life of the bond, resulting in an annual amortization amount of $11,700 ($117,000 / 10) and therefore a semiannual amortization of $5,850 ($11,700 / 2).

Next, we calculate the actual interest payment for the six-month period. The bond has a stated interest rate of 9%, so the annual interest payment is $270,000 (9% of $3,000,000), and the semiannual payment is $135,000 ($270,000 / 2). This amount includes the accrued interest from April 1st to June 30th before the bonds were issued.

Subsequently, the total interest expense recorded on October 1, 2010, would be the sum of the actual interest payment and the amortization of the discount: $135,000 + $5,850 = $140,850. Giving that the interest payment is a debit and the amortization of the discount is also a debit, the total debit to "interest expense" would be $140,850.