Financial Accounting and Reporting-CPA Practice Exam

What is the effective interest rate for bonds primarily used to determine?

1. The bond maturity date.

2. The market rate of interest.

3. The interest expense for the period.

4. The total proceeds from the bond sale.

The correct answer is: The interest expense for the period.

The effective interest rate on bonds is primarily used to determine the interest expense for the period. This rate reflects the actual cost of borrowing for the issuer when the bonds are sold, taking into account the issue price, the face value, any associated premiums or discounts, and the time to maturity. Interest expense is calculated by multiplying the carrying amount of the bond at the beginning of the period by the effective interest rate. This calculation provides a more accurate representation of the true expense incurred for that period, as opposed to simply using the stated interest rate on the bond, especially when the bond was issued at a premium or discount. In contrast, other options relate to different aspects of bond issuance. The bond maturity date pertains to when the issuer must repay the principal amount. The market rate of interest refers to the prevailing rates in the economy, which can fluctuate and affect bond pricing but does not directly dictate interest expense. Finally, the total proceeds from the bond sale involve the cash received upon issuance, which also depends on factors like market conditions and bonds’ characteristics but is not directly reflective of the effective interest rate’s impact on interest expenses.