Multiple Choice
Which of the following is true of zero coupon bonds?
11. Long Term Liabilities
Zero Coupon Bonds
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On January 1, ABC Company issues $1,000,000 of zero coupon bonds at 75. The bonds mature in five years. Assuming that ABC uses the straight-line method for amortization of bond premiums and discounts, the journal entry at the end of the first year would include:
A
A credit to Cash of $50,000
B
A credit to Interest Payable of $50,000
C
A credit to Discounts on Bonds Payable of $50,000
D
A credit to Bonds Payable of $50,000
E
None of the above
Verified step by step guidance1
Determine the initial carrying amount of the bonds by multiplying the face value of the bonds ($1,000,000) by the issue price percentage (75%). This gives the initial carrying amount of the bonds.
Calculate the total discount on the bonds by subtracting the initial carrying amount from the face value of the bonds. This represents the total amount of discount that needs to be amortized over the life of the bonds.
Since the straight-line method is used for amortization, divide the total discount by the number of years until maturity (5 years) to find the annual amortization amount.
At the end of the first year, the journal entry will include a debit to Interest Expense for the annual amortization amount and a credit to Discounts on Bonds Payable for the same amount, reflecting the reduction in the discount.
Review the options provided in the problem to identify the correct journal entry. The correct entry should include a credit to Discounts on Bonds Payable for the annual amortization amount calculated in the previous step.
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