Question

When bonds are sold at a premium and the effective interest method is used, at each subsequent interest payment date, the cash paid is:
A. Less than the effective interest.
B. Equal to the effective interest.
C.Greater than the effective interest.
D. More than if the bonds had been sold at a discount.

Answer 1

Answer:

C.Greater than the effective interest.

Explanation:

example

face value 1,000,000

issued at 1,100,000

premium of 100,000

the bond rate is 8%

and the effective rate is 6%

1,100,000 x 6%/2 = 33,000 interest expense

cash proceeds 1,000,000 x 8%/2 = 40,000 cash

amortization on premium 40,000 - 33,000 = 7,000

The cash payment (40,000) are greater than the effective interest (33,000)

If that wouldn't be the case, he premium won't depreciate