Final answer:
Interest expense under the effective-interest method is calculated by multiplying the carrying value of the bonds by the effective-interest rate, not the face value or the stated interest rate. An example calculation demonstrates present discounted value of bond payments at different discount rates.
Step-by-step explanation:
Under the effective-interest method of amortization, interest expense each period can be calculated by multiplying the carrying value of the bonds times the effective-interest rate for the appropriate time period. This means the correct answer is a) the carrying value of the bonds times the effective-interest rate for the appropriate time period. The carrying value is adjusted each period for the amortization of bond discount or premium, which is why the effective-interest rate is applied to the carrying value rather than the face value of the bonds.
Using the provided bond example, when calculating the present discounted value of the bond's cash flows, if the discount rate is 8%, we would calculate the present value of $240 received at the end of the first year and $3,240 ($240 interest + $3,000 principal) received at the end of the second year using the 8% rate. If the discount rate increased to 11%, the present value of these cash flows would be recalculated using the new rate, reflecting the impact of interest rate risk on bond valuation.