Question

Webb Company has outstanding a 7% annual, 10-year, $100,000 face value bond that it had issued several years ago. It originally sold the bond to yield 6% annual interest. Webb uses the effective interest rate method to amortize the bond premium. On June 30, 2014, the outstanding bond's carrying amount was $105,000.

a. What amount of unamortized premium on the bond should Webb report in its June 30, 2015, balance sheet?

Answer 1

The unamortized premium on the bond on June 30, 2015, would be $104,300, calculated by subtracting the annual premium amortization of $700 from the previous carrying amount of $105,000.

Step-by-step explanation:

To find the unamortized premium on Webb Company's bond as of June 30, 2015, we must first calculate the interest expense for the year, which is based on the carrying amount of the bond and the market rate at issuance. For a bond with a carrying amount of $105,000 and a market yield of 6% when it was issued, the interest expense for one year would be $105,000 times 6%, which equals $6,300. However, the bond pays 7% of the face value in cash interest, which is $100,000 times 7%, equalling $7,000. The difference between the cash interest paid and the interest expense is the amount by which the premium is amortized each year.

The amortization of the premium for one year would be $7,000 (cash interest paid) minus $6,300 (interest expense) equals $700. Subtracting this from the carrying amount of $105,000, the unamortized premium as of June 30, 2015, would be $105,000 minus $700, which is $104,300.

This procedure uses the effective interest rate method, reflecting that the premium is being reduced over time as it is being amortized against interest expense.