A firm has 5 debentures of Rs 200,000 each, bearing 8% interest, issued at 96. The discount is to be amortized straight‑line over the 5‑year term. Calculate the total interest expense for the first year.
Answer
Interest expense for the first year = Rs 88,000
The correct answer is Interest expense for the first year = Rs 88,000 — Total interest expense = cash interest + amortized discount = Rs 80,000 + Rs 8,000 = Rs 88,000.
Step-by-step solution
- Total face value = 5 × Rs 200,000 = Rs 1,000,000.
- Discount per debenture = 4% of Rs 200,000 = Rs 8,000; total discount = 5 × Rs 8,000 = Rs 40,000.
- Amortization per year = Rs 40,000 ÷ 5 = Rs 8,000.
- Annual cash interest = 8% of face value = 0.08 × Rs 1,000,000 = Rs 80,000.
- Total interest expense = cash interest + amortized discount = Rs 80,000 + Rs 8,000 = Rs 88,000.
Common mistake: Ignoring the amortized discount and reporting only cash interest
Concept tested: Amortization of discount on debentures
Published · How this solution was prepared and checked
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