"A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% (market rate) on January 1, 2007. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using effective-interest amortization, how much interest expense will be recognized in 2007

Interest expense for the year : 1,530,505.41

Explanation:

In the effective method the interest expense si determinate by multiplying the market rate with the carrying value.

Then, the difference against the cash outlay and this interest expense will amortize the bond discount:

PeriodB Carrying Cash outlayInt. Exp.  AmortCarrying Value

119,604,145800000764561.6635438.3419,639,583

219,639,583800000765943.7534056.2519,673,640

Total interest expense:

764,561.66 + 765,943.75  = 1,530,505.41

Then 800,000 - 764,561.66 = 35,438.34 amortization

new carrying value 19,604,145 + 35,438.34 = 19,639,583

Last: 19,638,583 x 0.078/2 = 765943.75

We add up the interst expense:

Total interest expense:

764,561.66 + 765,943.75  = 1,530,505.41

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