Question

When bonds are issued at a discount and the effective interest method is used for amortization, at each subsequent interest payment date, the cash paid is:

Answer 1

Question Completion:

A. More than the effective interest.

B. Less than the effective interest.

C. Equal to the effective interest.

D. More than if the bonds had been sold at a premium

Answer:

When bonds are issued at a discount and the effective interest method is used for amortization, at each subsequent interest payment date, the cash paid is:

B. Less than the effective interest.

Explanation:

This cash payment is the product of the bond's face value multiplied by the coupon rate.  The interest expense is increased by the amortized portion of the discount for the particular period.  This means that the interest expense will be higher than the cash payment for interest because of the discount granted at issuance.  And the interest expense is the product of the outstanding debt multiplied by the effective interest rate.