Under the effective interest method, which calculation represents interest expense?

Under the effective interest method, which calculation represents interest expense?

• A. Face value × stated rate
• B. Carrying amount × market rate at issue
• C. Carrying amount × coupon rate
• D. Interest paid

Answer: (B)

Under the effective interest method, interest expense is determined by applying the bond’s carrying amount at the start of the period to the bond’s effective interest rate (the market rate at issue). This rate reflects the true cost of borrowing and causes interest expense to fluctuate as the carrying amount is amortized toward the face value. The cash interest paid to holders comes from the stated coupon rate times the face value, which is separate from the expense calculation. Using the carrying amount multiplied by the market rate at issue captures the true expense under this method, making the calculation the correct representation of interest expense.

Under the effective interest method, interest expense is determined by applying the bond’s carrying amount at the start of the period to the bond’s effective interest rate (the market rate at issue). This rate reflects the true cost of borrowing and causes interest expense to fluctuate as the carrying amount is amortized toward the face value. The cash interest paid to holders comes from the stated coupon rate times the face value, which is separate from the expense calculation. Using the carrying amount multiplied by the market rate at issue captures the true expense under this method, making the calculation the correct representation of interest expense.