Knight Corporation
 wholesales auto parts to auto manufacturers. On March 1,2012, Knight Corporation issued $ 17,500,000 of five-year, 12% bonds at a market (effective) interest rate of 10%, receiving cash of $18,851,252. interest is payable semiannually, Knight Corporation’s fiscal year begins on March 1. The company uses the interest method.
a. Journalize the entries to record the following:
1. Sale of the bonds.
2. First semiannual interest payment, including amortization of premium. Round to the nearest dollar.
3. Second semiannual interest payment, including amortization of premium. Round to the nearest dollar.
b. Determine the bond interest expense for the first year.
c. Explain why the company was able to issue the bonds for $18,851,252 rather than for the face amount of $17,500,000.

a. 1. Cash...................................................................................... 18,851,252

Premium on Bonds Payable........................................... 1,351,252

Bonds Payable................................................................ 17,500,000

2. Interest Expense................................................................... 942,563*

Premium on Bonds Payable........................................... 107,437

................................................................................ Cash 1,050,000

*$18,851,252 × 5%

3. Interest Expense................................................................... 937,191*

Premium on Bonds Payable........................................... 112,809

................................................................................ Cash 1,050,000

*($18,851,252 - $107,437) × 5%

b. Annual interest paid................................................................... $2,100,000

Less premium amortized............................................................ 220,246*

Interest expense for first year..................................................... $1,879,754

*$107,437 + $112,809

c. The bonds sell for more than their face amount because the market rate of interest is greater than the contract rate of interest. This is because investors are willing to pay more for bonds that pay a higher rate of interest (contract rate) than the rate they could earn on similar bonds (market rate).