Question

The Bradford Company issued 12% bonds, dated January 1, with a face amount of $96 million on January 1, 2018. The bonds mature on December 31, 2027 (10 years). For bonds of similar risk and maturity, the market yield is 14%. Interest is paid semiannually on June 30 and December 31. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: 1. Determine the price of the bonds at January 1, 2018. 2. to 4. Prepare the journal entry to record their issuance by The Bradford Company on January 1, 2018, interest on June 30, 2018 and interest on December 31, 2018 (at the effective rate).

Answer 1

The effective interest rate is also called as market rate. It is the investor's yield maturity. When the effective interest rate is higher as compared bond coupon rate then, the bonds were issued at a discount. The Discount is then amortised over the period of bond by using effective interest rate method.

Under this method, interest expense is derived by multiplying the bond carrying value with the effective interest rate applicable when the bonds were issued. The difference between the interest expense and actual interest paid is the discount which will be amortised.