Question

Sheridan Company purchased $1750000 of 10% bonds of Scott Company on January 1, 2021, paying $1650375. The bonds mature January 1, 2031; interest is payable each July 1 and January 1. The discount of $99625 provides an effective yield of 11%. Sheridan Company uses the effective-interest method and plans to hold these bonds to maturity.
On July 1, 2021, Sheridan Company should increase its Debt Investments account for the Scott Company bonds by:

a. $4981.
b. $3271.
c. $6541.
d. $9963.

Answer 1

Answer:

B) $3271.

Explanation:

Since Sheridan Company uses the effective interest method to account for Scott Company bonds, and it purchased them on discount, it must increase its debt investments by:

(market price x effective interest) - (face value x coupon rate) =  

($1,650,375 x .055) - ($1,750,000 x .05) = $3,270.63 ≈ $3,271

since the bonds pay a semiannual coupon, the yearly interest rates must be divided by 2.