Question

Amortizing the discount on a bond payable:

a) decreases the face value of the bonds
b) increases the carrying amount of the bonds
c) increases the face value of the bonds
d) decreases the carrying amount of the bonds

Answer 1

Amortizing the discount on a bond payable increases the carrying amount of the bonds; the face value remains the same. For Ford's $5,000 bond with $150 annual payments, the interest rate is 3%. If market rates rise to 4%, the bond's value would decrease.

Step-by-step explanation:

Amortizing the discount on a bond payable increases the carrying amount of the bonds. The process of amortization involves gradually reducing the discount on the bonds payable over the life of the bond by charging it to expense. This effectively increases the carrying amount (the net amount at which the bonds are reported on the balance sheet) of the bonds until it equals the face value at maturity. It does not affect the face value of the bonds, which remains fixed at issuance.

Considering the provided example of Ford Motor Company issuing a five-year bond with a face value of $5,000 that pays an annual coupon payment of $150:

1. The interest rate Ford is paying on the borrowed funds would be calculated as ($150 / $5,000) * 100%, which equates to 3%.
2. If the market interest rate rises from 3% to 4%, the value of the bond would decrease as the newly issued bonds would offer higher interest rates, making the existing bond less attractive to investors unless it is sold for less (at a discount).