Question

Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased

$50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane on January 1,
20X4, for $53,000. The bonds have a 10-year maturity from the date of issue and pay interest semiannually. The bonds are accounted for
using straight-line amortization of premiums and discounts.
Gary’s reported net income of $20,000 for 20X6, and Kruse reported income (excluding income from ownership of Gary’s stock) of
$40,000.
Required
Select the correct answer for each of the following questions.

1. What amount of interest expense does Kruse record 20X6?
a. $4,000
b. $4,700
c. $5,000
d. $10,000

Answer 1

To calculate the interest expense, determine the premium amortization and subtract it from the interest payment.

Step-by-step explanation:

To calculate the amount of interest expense Kruse Corporation records in 20X6, we need to determine the effective interest rate of the bonds. The bond was purchased for $58,000, but had a face value of $50,000. The difference of $8,000 is considered a premium and will be amortized over the life of the bond. Since the bond has a 10-year maturity and pays interest semiannually, there will be 20 interest payments over the bond's life.

The annual interest expense would be $10,000 ($50,000 x 10%), so each semiannual interest payment would be $5,000. To calculate the premium amortization, divide the $8,000 premium by the 20 interest payments, resulting in a $400 premium amortization for each interest payment. Therefore, the interest expense that Kruse Corporation records in 20X6 would be $4,700 ($5,000 interest payment - $400 premium amortization).