This question comes from one of the Schweser mocks.
Company issued a 5-year, $50 million face, 6% semiannual bond when market interest rates were 7%. The market yield of the bonds was 8% at the beginning of the next year. What is the interest expense that the company should report for the first half of the second year of the bond’s life (third semiannual period).
I understand that you have to get the PV of the bond at the beginning of the second year, then multiply that by the interest rate. The solutions does this but it uses 3.5% instead of 4.0%. " The subsequent change in the market rate has no effect on the amortization of the discount." Why is this?
The effective interest rate method uses carrying values, not market values. The market value can bounce around all it wants to, but the issuer is basically locked in to amortizing the discount @ 7% over the life of the bond.
Bonds payable are shown at par value with any premium or discount amortized over the life of the bonds; they are not shown at market value. As breadmaker says, the only market rate that matters is the one at issuance.