At the beginning of Year 4, Tucks Inc. issued a $810,000, 3%, 5 year, semi-annua

Question

At the beginning of Year 4, Tucks Inc. issued a $810,000, 3%, 5 year, semi-annual bond for $775,000 (a 4% effective interest rate). Tucks has traditionally used the straight line method to amortize premiums and discounts. However, at the end of Year 5 the company decided that they should be using the effective interest method instead and switched methods

1.) What did Tucks report as interest expense during years 4 & 5 using the straight line method? What would they have reported as interest expense for if they had used the effective interest method instead?

Explanation / Answer

Solution.

1.) What did Tucks report as interest expense during years 4 & 5 using the straight line method.

Face value of Bond = $810,000

Coupon rate = 3%

Time period = 5 year.

Market interest rate = 4%

Semi annual coupon payment = $810,000 x 3%/2 = $12,150 x 8.98259 = $109,138.41

Face value = $810,000 x 0.82035 = $664,482.12

Bond price = ($109,138.41 + $664,482.12 ) = $773,621

Amount of discount = $36,379

After bond valuation we can get this bond issue on discount.

Interest payable = $810,000 x 3% = $24,300

Bond discount = $773,621 x 4% = $30,945

$30,945 - $24,300 = $6,645.

Interest expense = $30,945

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