On January 1, 2010, Learned, Inc., issued $60 million face amount of 20-year, 14% stated rate bonds when market interest rates were 16%. The bonds pay interest semiannually each June 30 and December 31 and mature on December 31, 2029.
a. Using the present value tables in Chapter 6, calculate the proceeds (issue price) of Learned, Inc.’s, bonds on January 1, 2010, assuming that the bonds were sold to provide a market rate of return to the investor.
b. Assume instead that the proceeds were $62,000,000. Use the horizontal model (or write the journal entry) to record the payment of semiannual interest and the related premium amortization on June 30, 2010, assuming that the premium of $2,000,000 is amortized on a straight-line basis.
c. If the premium in part b were amortized using the compound interest method, would interest expense for the year ended December 31, 2010, be more than, less than, or equal to the interest expense reported using the straight-line method of premium amortization? Explain.
d. In reality, the difference between the stated interest rate and the market rate would be substantially less than 2%. The dramatic difference in this problem was designed so that you could use present value tables to answer part a. What causes the stated rate to be different from the market rate, and why is the difference likely to be much less than depicted in this problem?