6) on July 1, year 1, young co. purchases as a long-term investment $500,000 of

Question

6) on July 1, year 1, young co. purchases as a long-term investment $500,000 of Paul,Inc’s  8 % bonds for $473,000. Including accrued interest of $20,000. The bonds were purchased to yield 10% interest and were properly classified as held-to maturity securities. The bonds mature on January 2, year 8. And pay interest annually on January 1. Young uses the effective interest method of amortization. In its December 31, year 1. Balance sheet, what amount should young report as investment in bonds?

A. $455,650

B. $458,300

C. $476,650

D. $480,300

Explanation / Answer

SOLUTION

Correct option is Option A i.e $455,650

The bond investment’s original balance was $453,000 ($473,000 price - $20,000 accrued interest) because the carrying amount does not include accrued interest paid.

Under the effective interest method, interest income equals the yield or effective interest rate times the carrying amount of the bonds at the beginning of the interest period. The amortization of premium or discount is the difference between this interest income and the periodic cash payments/

For Year 1, interest income is $22,650 [$453,000 * 10% * (6 / 12)] , and the actual interest is $20,000 [$500,000 * 8% * (6 / 12)].

Hence, the carrying amount at year-end is $455,650 [$453,000 + ($22,650 - $20,000)].

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