Question

Basil Corporation issues for cash $1,000,000 of 8%, 10-year bonds, interest payable annually, at a time when themarket rate of interest is 7%. The straight-line method is adopted for the amortization of bond discount orpremium. Which of the following statements is true?
a.The carrying amount increases from its amount at issuance date to $1,000,000 at maturity.
b.The carrying amount decreases from its amount at issuance date to $1,000,000 at maturity.
c.The amount of annual interest paid to bondholders increases over the 10-year life of the bonds.
d.The amount of annual interest expense decreases as the bonds approach maturity.

Answer 1

Answer:

b.The carrying amount decreases from its amount at issuance date to $1,000,000 at maturity.

Explanation:

as the market rate was lower than the bond rate, their market price will be higher than face value and so, a bond premium will arise.

The bond premium increase the carrying value of the bonds and will be amortizate over the life of the bonds.

so we have:

1,000,000 + premium = carrying value

over the course fo the years, the premium will decrease therefore, so the carring value. In the end (maturity), the premium will be zero and carring valeu will equal the face value.

It will make statement b correct.