On January 2, Year 4, Nast Co. issued 8% bonds with a face amount of $1 million that mature on January 2, Year 10. The bonds wer
1 answer:
Answer:
Option A: [Overstated , No effect]
Explanation:
December 31, 20X1: Overstated; January 2, 20X7: No effect
Our term period is from January 2, Year 4 to January 2, Year 10.
Total Term = 6 years.
The straight-line method uses a constant expense for the whole term, whereas, the effective-interest method uses a gradually increasing expense.
Let, us calculate the carrying amount with both approaches
After 1st Year:
Carrying amount on 2-Jan-Year1 = $1,000,000 - $150,000
Carrying amount on Year 1 = $850,000
Discount Amortization will be:
By Straight-Line Method = $150,000 / 6 yrs
By Straight-Line Method = $25,000 / yr
By Effective-Interest Method = ($850,000 * 12%) - ($1,000,000 * 8%)
By Effective-Interest Method = $22,000
Carrying amount on 31-Jan-Year1:
By Straight-Line Method = $850,000 + $25,000
By Straight-Line Method = $875,000
By Effective-Interest Method = $850,000 + $22,000
By Effective-Interest Method = $872,000
Difference of carrying value (Straight-line vs Effective Interest) will be obtained by subtracting.
Difference in Carrying Value = $875,000 - $872,000
Difference in Carrying Value = $3,000
Hence, for 1 Year period, straight-line method gives an overstatement as compared to effective-interest method.
After 6 Years:
For both approaches, the total carrying amounts at the term's end must be equal. As the same total discount amortization will occur under each method.
Hence, for 6 years period, use of any method will have no effect on the carrying amount.
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