Amortize Premium by Interest Method

Shunda Corporation wholesales parts to appliance manufacturers. On January 1, Year 1, Shunda Corporation issued $22,000,000 of five-year, 9% bonds at a market (effective) interest rate of 7%, receiving cash of $23,829,684. Interest is payable semiannually. Shunda Corporation’s fiscal year begins on January 1. The company uses the interest method.

a. Journalize the entries to record the following:
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1. Sale of the bonds. Round amounts to the nearest dollar. For a compound transaction, if an amount box does not require an entry, leave it blank.
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2. First semiannual interest payment, including amortization of premium. Round to the nearest dollar. For a compound transaction, if an amount box does not require an entry, leave it blank.
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3. Second semiannual interest payment, including amortization of premium. Round to the nearest dollar. For a compound transaction, if an amount box does not require an entry, leave it blank.
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b. Determine the bond interest expense for the first year. Enter amounts as positive numbers. Round amounts to the nearest dollar.
Annual interest paid $
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Premium amortized
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Interest expense for first year $
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c. Explain why the company was able to issue the bonds for $23,829,684 rather than for the face amount of $22,000,000.

The bonds sell for more than their face amount because the market rate of interest is
the contract rate of interest. Investors
willing to pay more for bonds that pay a higher rate of interest (contract rate) than the rate they could earn on similar bonds (market rate).