[Exercise 3]
On January 1, 2011, Company A issues longterms bonds which are due on
January 1, 2016. Interest is paid semiannually on January 1 and
July 1 each year. Face amount of bonds is $500,000 with stated
interest rate (coupon rate) of 10%. At the time of issuance,
market interest rate is 12%.
As explained in Exercise 1, the price of bonds is $463,202, and
bonds will be sold at $36,798 discount from the face amount of
$500,000.
Calculate the amortization of discount on bonds using
effective
interest method. 
[Solution to Exercise
3]
Date 
Interest paid 
Effective interest rate for semiannual period 
Interest expense 
Amortization of discount 
Present
value of bonds 
1/1/2011 




$463,202 
7/1/2011 
$25,000 
6% 
$27,792 
$2,792 
$465,994 
1/1/2012 
$25,000 
6% 
$27,960 
$2,960 
$468,954 
7/1/2012 
$25,000 
6% 
$28,137 
$3,137 
$472,091 
1/1/2013 
$25,000 
6% 
$28,325 
$3,325 
$475,416 
7/1/2013 
$25,000 
6% 
$28,525 
$3,525 
$478,941 
1/1/2014 
$25,000 
6% 
$28,736 
$3,736 
$482,678 
7/1/2014 
$25,000 
6% 
$28,961 
$3,961 
$486,639 
1/1/2015 
$25,000 
6% 
$29,198 
$4,198 
$490,837 
7/1/2015 
$25,000 
6% 
$29,450 
$4,450 
$495,287 
1/1/2016 
$25,000 
6% 
$29,713 
$4,713 
$500,000 
Interest payment each semiannual period
= $500,000 x 5%
= $25,000
(Coupon rate for a semiannual period = 10% / 2 = 5%.)
Effective interest rate =
Market interest rate = 12%
Effective interest rate for a semiannual period = 12% / 2 = 6%
Interest expense
= Present value of bonds at the beginning of the period
x Effective interest rate for
the period
[1/1/2011  7/1/2011] > $463,202 x 6% =
$27,792
[7/1/2011  1/1/2012] > $465,994 x 6% =
$27,960
Amortization of discount on bonds
= Interest expense  Interest paid
[1/1/2011  7/1/2011] > $27,792  $25,000
= $2,792
[7/1/2011  1/1/2012] > $27,960  $25,000
= $2,960
Ending present value of bonds
= Beginning present value of bonds
+ Amortization of
discount on bonds
[1/1/2011  7/1/2011] > $463,202 + $2,792
= $465,994
[7/1/2011  1/1/2012] > $465,994 + $2,960
= $468,954
