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Cramer Company sold five-year, 8% bonds on October 1, 2018. The face amount of the bonds was $100,000, while the issue price was $102,000. Interest is payable on April 1 of each year. The fiscal year of Cramer Company ends on December 31. How much interest expense will Cramer Company report in its December 31, 2018, income statement (assume straight-line amortization)?

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Answer:

Interest expense reported by Cramer is $1900.

Explanation:

The interest is due for 3 months.

Cash interest here will be

=  Face amount of bond x interest rate x (No. of months the interest is due / Total number of months in a year)

= $100000 x 8% x (3 months/ 12 months)

= $8000 x 3/12

= $2000

Now, the amount of premium to be amortized

= Issued amount of bonds - Face amount of bonds

= $102000 - $100000

= $2000  

And, the premium amortization (for 3 months)

= Amount of premium x (1/ Duration of bonds) x (No. of months / Total number of months in a year)

= $2000 x (1 year/ 5 years) x (3 months / 12 months)

= $2000 x 1/5 x 3/12

= $400 x 3/12

= $100

So, Interest expense

= Cash interest - Premium amortization  

= $2000 - $100

= $1900

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