Question

On January 1, ABC, Inc., issued $100,000 of 10%, 5-year bonds, for $92,280. Interest is due semiannually. When ABC records the first interest payment, which will be greater the debit to Interest Expense or the credit to Cash?
A.The debit to Interest Expense will be greater because the market rate is greater than the stated interest rate.

B.The debit to Interest Expense will be less because the market rate is greater than the stated interest rate.

C.The debit to Interest Expense will be greater because the market rate is less than the stated interest rate.

D.The debit to Interest Expense will be lower because the market rate is less than the stated interest rate.

Answer 1

Answer:

A. The debit to Interest Expense will be greater because the market rate is greater than the stated interest rate.

Explanation:

The effective interest rate is the market rate which is real rate of interest payment after incorporating the compounding effect. When the effective interest rate is greater than the stated the bond will sell at discount. The stated interest rate determines the amount of interest borrower will have to pay. The effective interest rate lead to higher returns than stated interest rate.