On January 1, 2014, Mustafa Limited paid $537,907.40 for 12% bonds with a maturity value of $500,000. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2014, and mature on January 1, 2019, with interest receivable on December 31 of each year. Mustafa accounts for the bonds using the amortized cost approach, applies ASPE using the effective interest method, and has a December 31 year end.
(a) Prepare the journal entry to record the bond purchase.
(b) Prepare a bond amortization schedule, rounding to two decimal places.
(c) Prepare the journal entry to record interest received and interest income for 2014.
(d) Prepare the journal entry to record interest received and interest income for 2015.
(e) Prepare the journal entry to record the redemption of the bond at maturity.
(f) If Mustafa used the straight-line method of discount/premium amortization, prepare the journal entry to record interest received and interest income the company would make each year.
(g) Compare the total interest income reported over the five-year period under the effective interest method and the straight-line method. What can you conclude?
(h) Why might a reader of the financial statements find the effective interest method more relevant than the straight line method?