Question

Question: Zopf Company sells its bonds at a premium and applies the effective-interest method in amortizing the premium. Will the annual interest expense increase or decrease over the life of the bonds? Explain.

Short answer

Answer

The annual interest expense will decrease each period all over the duration of the bonds. When bonds are sold at a premium, their carrying value falls to par value throughout their life; thus, the interest expense also falls.

Step-by-step solution

Meaning of annual interest expense

Interest expense is considered a non-operating expense showed on the income statement.

Decrease in the annual interest expense over the life of bonds

In the effective-interest method, the interest expense for each period is similar to the yield interest rate or effective interest rate times the carrying value of the bonds at the starting of each interest period. Carrying value descends to maturity value throughout their life, when the bonds are sold at a premium, consequently, the interest expense also declines.