A company issues 600000 in zerocoupon bonds on January 1 Yea

A company issues $600,000 in zero-coupon bonds on January 1, Year One. They come due in exactly six years and are sold to yield an effective interest rate of 4 percent per year. They are issued for $474,186. The effective rate method is applied. a. What interest expense was recognized for Year One and for Year Two? b. How would the company’s net income have been affected in each of the first two years if the straight-line method had been used rather than the effective rate method?

Solution

a. If effective rate method is applied, The interest expense recognised for :

Year 1 = $474186 * 4% = $18967

year 2 = ($474186 + $18967) * 4% = $19726

b. if the straight-line method had been used, the net income have been affected by :

Year 1 & 2 = (600000 - 474186) / 6 = $20969