Question: Issuers of deep discount or zero coupon debt securities must use

Issuers of “deep-discount” or “zero coupon” debt securities must use an effective interest approach to amortization of discount for both tax reporting and reporting to the public. Similarly, buyers of such securities must record interest income under the effective interest rate method.
1. Assume that, in order to develop improvements for the Kindle, issues a 10-year zero coupon bond having a face amount of $50,000,000 to yield 10%. For simplicity, assume that the 10% yield is compounded annually. Prepare the journal entry for (the issuer).
2. Prepare the journal entry for interest expense for the first full year and the second full year using
(a) Straight-line,
(b) Effective interest amortization.
3. Assume an income tax rate of 40%. How much more income tax for the first year would the issuer have to pay because of applying effective interest instead of straight-line amortization?
4. What kinds of borrowers might prefer these investments over bonds that pay interest immediately?

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  • CreatedFebruary 20, 2015
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