Question

(Amortization Schedule—Effective-Interest) Assume the same information as E14-6.

Instructions

Set up a schedule of interest expense and discount amortization under the effective-interest method. (Hint: The effective-interest rate must be computed.)

Short answer

The effective interest rate is12%.

Step-by-step solution

Definition of Discount Amortization

Discount amortization is the method used by the business entity that has issued its bonds at a discount to spread the discount value over the life of the bond. The discount can be amortized by using the effective interest method or by using the straight-line method of amortization.

Amortization table under effective interest method

Date	Cash interest paid at stated rate on bond payable (10%)	Interest expenses at market rate on book value of bonds (12%)	Discount amortized	Unamortized discount	Bond payable	Book value
1 Jan 2017				$144,184	$2,000,000	$1,855,816
1 Jan 2018	$200,000	$222,698	$22,698	$121,486	$2,000,000	$1,878,514
1 Jan 2019	$200,000	$225,422	$25,422	$96,064	$2,000,000	$1,974,578
1 Jan 2020	$200,000	$236,949	$36,949	$59,115	$2,000,000	$2,033,693
1 Jan 2021	$200,000	$244,043	$44,043	$15,072	$2,000,000	$2,015,072
1 Jan 2022	$200,000	$241,809	$41,809	$0	$2,000,000	$200,000

Note: The present value calculated under 12% is nearer to the issue price of the bonds.

Working note: Calculation of effective interest rate

Calculation of present value at 11%:

Particular	Amount $
Present value of the bonds payable $2,000,000 (n=5, r=11%) (0.5935)	$1,187,000
Present value of the interest $200,000 (n=5, r=11%) (3.70)	740,000
Total present value	$1,927,000

Calculation of present value at 12%:

Particular	Amount $
Present value of the bonds payable $2,000,000 (n=5, r=12%) (0.5674)	$1,134,800
Present value of the interest $200,000 (n=5, r=12%) (3.605)	721,000
Total present value	$1,855,800