Question

Cramer Company sold five-year, 8% bonds on October 1, 2016. The face amount of the bonds was $100,000, while the issue price was $102,000. Interest is payable on April 1 of each year. The fiscal year of Cramer Company ends on December 31. How much interest expense will Cramer Company report in its December 31, 2016, income statement (assume straight-line amortization)?

a) $2,000.

b) $1,900.

c) $1,778.

d) $2,040.

Answer 1

Cramer Company will report interest expense of $1,900 on its December 31, 2016, income statement, which includes three months of accrued interest and the straight-line amortization of the bond premium for the period.

Step-by-step explanation:

To calculate Cramer Company's interest expense for the December 31, 2016, income statement, we need to consider both the cash interest payment and the amortization of the bond premium. Given that the bonds were issued at $102,000, which is a $2,000 premium over the face amount of $100,000, and that they are five-year bonds, the annual straight-line amortization of the premium is $400 ($2,000 premium divided by 5 years).

The annual cash interest payment is $8,000 (8% of the $100,000 face value). However, since the bonds were sold on October 1, 2016, only three months of interest would have accrued by December 31, 2016. The interest expense for three months is $2,000 (quarter of the annual interest).

Therefore, the total interest expense for 2016 is the cash interest minus the amortized premium for the period: $2,000 - ($400 ÷ 4) = $1,900.

The correct answer is b) $1,900.