On January 1, 2021, an investor paid $295,000 for bonds with a face amount of $315,000. The contract rate of interest is 8% while the current market rate of interest is 11%. Using the effective interest method, how much interest income is recognized by the investor in 2022 (assume annual interest payments and amortization)

The amount of interest income recognized by the investor in 2022 is $33,247.50.

Explanation:

We are given the following in the question:

Amount paid by an investor = $295,000

Bond face amount =  $315,000

Contract interest rate = 8%

Current market interest rate = 11%.

Therefore, we have:

Interest amount paid in cash = Bond face amount * Contract interest rate = $315,000 * 8% = $25,200

Amount recognized as interest expense by bond issuer = Amount paid by an investor * Current market interest rate = $295,000 * 11% = $32,450

Bond’s carrying value on 31 December 2021 = Amount paid by the investor + Amount recognized as interest expense by bond issuer - Interest amount paid in cash = $295,000 + $32,450 - $25,200 = $302,250

Year 2022 interest income = $302,250 * 11% = $33,247.50

Therefore, the amount of interest income recognized by the investor in 2022 is $33,247.50.

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