Question

On January 1, 2021, an investor paid $295,000 for bonds with a face amount of $315,000. The contract rate of interest is 8% while the current market rate of interest is 11%. Using the effective interest method, how much interest income is recognized by the investor in 2022 (assume annual interest payments and amortization)

Answer 1

The amount of interest income recognized by the investor in 2022 is $33,247.50.

Step-by-step explanation:

We are given the following in the question:

Amount paid by an investor = $295,000

Bond face amount = $315,000

Contract interest rate = 8%

Current market interest rate = 11%.

Therefore, we have:

Interest amount paid in cash = Bond face amount * Contract interest rate = $315,000 * 8% = $25,200

Amount recognized as interest expense by bond issuer = Amount paid by an investor * Current market interest rate = $295,000 * 11% = $32,450

Bond’s carrying value on 31 December 2021 = Amount paid by the investor + Amount recognized as interest expense by bond issuer - Interest amount paid in cash = $295,000 + $32,450 - $25,200 = $302,250

Year 2022 interest income = $302,250 * 11% = $33,247.50

Therefore, the amount of interest income recognized by the investor in 2022 is $33,247.50.