As part of their expansion plans, VPI, Inc. issued $1,000,000 in $1,000 face value, 10%, 10-year bonds on January 1, 2021. The bonds were issued for $1,135,906 (an 8% effective interest rate). Interest is payable semi-annually on 7/1 and 1/1. Premium amortization for the first year was originally calculated using the straight-line method of amortization. Maggie believes that the difference between using straight-line amortization and effective interest amortization is material.

• The accountants at VPI, Inc. made three entries related to these bonds during the year/in preparation of the financial statements. What were those entries? (Ignore any deferred income tax effects for now.)
• What would have the three entries been if the accountants at VPI, Inc. had used the effective interest rate method. (Ignore any deferred income tax effects for now.)
• If Maggie is correct that they are required to use the effective interest rate method to record the premium amortization, what entries would be necessary to adjust the accounts to the correct balances? (Note: Ignore any income tax effects for now.)

The Internal Revenue Code requires the use of the effective interest method in recording bond premium and discount amortization.

• Were there any deferred tax consequences to how VPI, Inc. initially recorded their bond premium amortization, and if so, what was the entry that would have been made to record those consequences?
• Would there be any deferred tax consequences if VPI, Inc. originally used the effective interest method in recording their bond premium amortization, and if so, what would be the entry that they would make to record those consequences?
• Will the deferred tax consequences change if VPI, Inc. switches to the effective interest method for book purposes, and if so, what entry will be necessary to adjust the accounts to their appropriate balances?

Answer rating: 100% (QA)

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