Straight-Line versus Effective-Interest Amortization
Response to the following problem:
Cyprus Corporation issued $150,000 of bonds on January 1, 2009, to raise funds to buy some special machinery. The maturity date of the bonds is January 1, 2014, with interest payable each January 1 and July 1. The stated rate of interest is 10%. When the bonds were sold, the effective rate of interest was 12%. The company's financial reporting year ends December 31.
Required:
1. Determine the price at which the bonds would be sold.
2. Prepare the amortization schedule using the effective-interest method.
3. Prepare a comparative schedule of interest expense for each year (2009-2014) for the effective-interest and straight-line methods of amortization.
4. Record the journal entry for the last payment using the amortization schedule in part (2).
5. Record the journal entry for the retirement of the bonds.
6. Interpretive Question: Is the difference between the interest expense each year between the straight-line and effective-interest methods sufficient to require the use of the effective-interest method? How do you think this question would be answered in practice?