The Ridgemont Company issues $20,000,000, 7.8%, 20-year bonds on 1/1/18. Interest is paid on June 30 and December 31. Effective rate is 8%. The bonds sold for $19,604,145. Using effective-interest amortization, what is the 2018 Interest Expense

The 2018 Interest Expenseis $1,568,498

Explanation:

As the bond is issued at discount

Discount on the bond = Face value - Issuance value = $20,000,000 - $19,604,145 = $395,855

The discount will be amortized and added to the interest payment to calculate the interest expense

The Interest Expense is calculated as follow

Interest expense = Interest payment in the period + Discount amortization

June 30, 2018

Interest payment = Face value x Coupo rate x semiannual fraction = $20,000,000 x 7.8% x 6/12 = $780,000

Discount amortization = ( Bond carrying value x Effective rate x semiannual fraction ) - Interest payment = ( $19,604,145 x 8% x 6/12 ) - $780,000 = $784,165.80  - $780,000 = $4,165.80 = $4,166

Interest expense = $780,000 + $4,166 = $784,166

Bond's Caryying value = $19,604,145 + $4,166 = $19,608,311

December 31, 2018

Discount amortization = ( Bond carrying value x Effective rate x semiannual fraction ) - Interest payment = ( $19,608,311 x 8% x 6/12 ) - $780,000 = $784,332  - $780,000 = $4,332

Interest expense = $780,000 + $4,332 = $784,332

2018

Interest expense = Interest expense on June 30, 2018 + Interest expense on December 31, 2018 = $784,166 + $784,332 = $1,568,498

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