Gordon’s Gadgets issued $ 2,000,000 of bonds on January 1, 2010. The bonds mature on January 1, 2018. Interest is payable annually each December 31. The stated rate of interest is 3%, and the market rate of interest was 2% at the time of issue.
1. Calculate the proceeds for the bond issue. How would issuing the bonds affect the financial statements for Gordon’s (on the date of issue)?
2. Prepare an amortization schedule for the first four years of the life of the bonds, showing the interest expense and the carrying value at the end of each interest period. Gordon’s uses the effective interest method for amortizing discounts and premiums.
3. How much interest expense related to these bonds would Gordon’s show on its income statement for the year ended December 31, 2015? (Assume effective interest method.)
4. Calculate the interest expense for the year ended December 31, 2015, using the straight- line method of amortization. Then, compare that amount to the amount calculated using the effective interest method. Which method do you think Gordon’s should use and why?