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CLEP Financial Accounting Exam Prep

Category - CLEP Financial Accounting Test Practice Questions

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A corporation issues $500,000 in 20-year cash bonds that have an 8% interest rate, payable annually. The current market rate is 7%. The corporation uses the straight-line method to amortize the bond discount or premium. Which of the following is true?
  1. The carrying amount increases from its amount at issuance to $500,000 at maturity.
  2. The carrying amount decreases from its amount at issuance to $500,000 at maturity.
  3. The annual interest paid to the bondholders increases over the next 20 years.
  4. The annual interest paid to the bondholders decreases as the bonds reach maturity.
  5. The bonds were sold at a discount.
Explanation
Answer - B - The carrying amount decreases from its amount at issuance to $500,000 at maturity, since the bonds were issued at 8% when the market rate was 7%

Key Takeaway: Bonds with a stated rate of 8% sold at a time when the market rate is 7% are sold at a premium. The carrying amount of the bonds is the face value plus the balance in the premium account. The premium is amortized over the life of the bonds until its balance is zero, thus the carrying amount is decreasing over the life of the bond.
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