Question

On January 1, Pacer Corporation issued $2,000,000, 13%, 5-year bonds with interest payable on July 1 and January 1. The bonds sold for $2,197,080. The market rate of interest for these bonds was 11%. On the first interest date, using the effective-interest method, the debit entry to Interest Expense is for Select one: a. $260,000. b. $130,000. c. $142,810. d. $241,679. e. $120,839.

Answer 1

Option E, is correct as effective interest $ 120,839

Step-by-step explanation:

The coupon interest payable semi-annually is computed thus:

Semi-annual coupon =13%/2*$2000000

=$130,000

However the bond was issued at premium, using effective interest the first interest payment is calculated on the actual issue value of the bond of $2,197,080 using the market rate of interest

effective interest=11%/2*$2,197,080

=$ 120,839.40

Hence,the interest expense based on effective interest is $120,839 rounded to the nearest whole number

Option D is wrong because the effective interest is a semi-annual interest not an annual one.