City of Falmouth: On Oct 1, 2027 issued $1,000,000 of 3%, 10-year term bonds with semiannual interest payments due on Apr 1 and Oct 1 each year, beginning Apr 1, 2028. What amount of expense should the city recognize in its governmental activities journal for the years 2027 and 2028?

• A. 9,000 in 2027; 90,000 in 2028.
• B. 7,500 in 2027; 30,000 in 2028.
• C. 0 in 2027; 45,000 in 2028.
• D. 75,000 in 2027; 75,000 in 2028.

Answer: (B)

The key idea is that governmental activities use accrual accounting for interest on long-term debt, recognizing interest as it is incurred, not only when cash is paid. The first bond period runs from Oct 1, 2027 to Apr 1, 2028, with a total semiannual interest of 15,000. Since year-end 2027 includes only three months of this period (Oct–Dec), interest accrued in 2027 is 1,000,000 × 3% × 3/12 = 7,500.

For 2028, interest is accrued for the full year (Jan–Dec), which is 1,000,000 × 3% = 30,000. The two semiannual payments in 2028 total 30,000 as well, but the expense recognized in 2028 equals the year’s accrual, 30,000, with the payments reducing cash and the interest payable when due.

So the correct recognition is 7,500 in 2027 and 30,000 in 2028.