ACCT 2110 Final jawn - ch. 9

interest expense formula

- Interest payment (Face X Rate X Time) + Discount amortization - Interest payment - Premium amortization

Interest amortization, two parts:

- actual interest payment made to the lender during the period - amortizing any premium or discount on the bond

When is straight line method useful?

- debt with regular interest payments sold at their face or par value - debt with regular interest payments sold for more (a premium) or less (a discount) than the face or par value

Leasing 3 advantages

1. Less cash - is needed to sign a lease than to purchase an asset. 2. Lease contracts offer protection against obsolescence and flexibility. 3.Lease contracts can provide lower cost financing through tax advantages.

Interest net of income taxes formula

= (1 - Tax rate) x Interest

effective interest expense formula

Carrying Value x Yield Value x Time (in years)

payment schedule

Debt requires specified payments to creditors on specified dates. Not flexible

When bonds sell at par

Equal to face value Interest expense = Interest paid

Interest Rate

Face Value x Interest Rate x Time (in years)

effective interest method formula

Face Value x Stated Value x Time (in years)

The accounting for notes payable and bonds payable is generally the same under

IFRS as it is for U.S. GAAP.

Long-term debt to equity ration

Long term debt/total equity

Is it always better to have lower debt to equity, debt to total assets, and long-term debt to equity ratios?

No. Debt provides opportunities for leverage. Think about it in this way—if you're guaranteed a return greater than your interest payments, it would not make sense to avoid borrowing. Of course, the reality is that while no returns are guaranteed, interest payments are unavoidable.

When a company borrows money from a bank, it typically signs a formal agreement or contract called a

Note or Note Payable

What is the primary negative attribute of debt?

Payment schedules

T or F, A business must weigh both the negative and positive aspects of debt financing in deciding whether or not to take the risk.

True

effective interest rate method

a method of interest amortization that is based on compound interest calculations. GAAP certified

A bond is

a type of note that requires the issuing entity to pay the face value of the bond to the holder when it matures and usually to pay interest periodically at a specified rate.

Willow Corporation's balance sheet showed the following amounts: current liabilities, $5,000; bonds payable $1,500; lease obligations, $2,300. Total stockholders' equity was $6,000. The debt to equity ratio is a. 1.47 b. 1.42 c. 0.83 d. 0.63

a. 1.47

If bonds are issued at 101.25, this means that a. a $1,000 bond sold for $1,012.50 b. a $1,000 bond sold for $101.25 c. the bonds are sold at discount d. the bond rate of interest is 10.125% of the market rate of interest

a. a $1,000 bond sold for $1,012.50

lease

an agreement that enables a company to use property without legally owning it.

straight-line method

an interest amortization method that amortizes equal amounts of premium or discount to interest expense each period.

Sean Corp. issued a $40,000, 10-year bond, with a stated rate of 8%, paid semiannually. How much cash will the bond investors receive at the end of the first interest period? a. $800 b. $1,600 c. $3,200 d. $4,000

b. $1,600

Bonds in the amount of $100,000 with a life of 10 years were issued by the Roundy Company. If the stated rate is 6% and interest is paid semiannually, what would be the total amount of interest paid over the life of the bonds? a. $120,000 b. $60,000 c. $30,000 d. $6,000

b. $60,000

Bonds are sold at a premium if the a. market rate of interest was more than the stated rate at the time of issue b. market rate of interest was less than the stated rate at the time of issue c. company will have to pay a premium to retire the bonds d. issuing company has a better reputation than the other companies in the same business

b. market rate of interest was less than the stated rate at the time of issue

Convertible bonds

bonds that allow the bondholder to convert the bond into another security—typically common stock.

Callable bonds

bonds that give the borrower the right to pay off (or call) the bonds prior to their due date.

Which of the following statements regarding bonds payable is true? a. Generally, bonds are issued in denominations of $100. b. When an issuing company's bonds are traded in the "secondary" market, the company will receive part of the proceeds when the bonds are sold from the first purchaser to the second purchaser. c. The entire principal amount of most bonds mature on a single date. d. A debenture bond is backed by specific assets of the issuing company.

c. The entire principal amount of most bonds mature on a single date

What best describes the discount on bonds payable account? a. a liability b. an asset c. a contra liability d. an expense

c. a contra liability

The premium on bonds payable account is shown on the balance sheet as a. a contra asset b. a reduction of an expense c. an addition to a long-term liability d. a subtraction from a long-term liability

c. an addition to a long-term liability

Bonds are a popular source of financing because a. a company having cash flow problems can postpone payment of interest to bondholders b. financial analysts tend to downgrade a company that has raised large amounts of cash by frequent issues of stock c. bond interest expense is deductible for tax purposes, while dividends paid on stock are not d. the bondholders can always convert their bonds into stock if they choose

c. bond interest expense is deductible for tax purposes, while dividends paid on stock are not

When bonds are issued at a discount, the interest expense for the period is the amount of interest payment for the period a. plus the premium amortization for the period b. minus the premium amortization for the period c. plus the discount amortization for the period d. minus the discount amortization for the period

c. plus the discount amortization for the period

On January 2, 2013, Sylvester Metals Co. leased a mining machine from EDH Leasing Corp. The lease qualifies as an operating lease. The annual payments are $4,000 paid at the end of each year, and the life of the lease is 10 years. What entry would Sylvester make when the machine is delivered by EDH? a. Prepaid Rent 40,000Lease Liability 40,000 b Leased Assets 40,000Lease Liability 40,000 c. Prepaid Rent 4,000Lease Liability 4,000 d. No entry is neccessary

d. No entry is neccessary

Which of the following lease conditions would result in a capital lease to the lessee? a. the lessee will return the property to the lessor at the end of the lease term b. the lease term is 70% of the property's economic life c. The fair market value of the property at the inception of the lease is $18,000; the present value of the minimum lease payments is $15,977 d. The lessee can purchase the property for $1 at the end of the lease term

d. The lessee can purchase the property for $1 at the end of the lease term

The result of using the effective interest method of amortization of the discount on bonds is that a. the cash interest payment is greater than the interest expense b. the amount of interest expense decreases each period c. the interest expense for each amortization period is constant d. a constant interest rate is charged against the debt carrying value

d. a constant interest rate is charged against the debt carrying value

Long-term debt

generally refers to obligations that extend beyond 1 year.

secured bond

has some collateral pledged against the corporation's ability to pay. Ex. Mortgage Bonds

Debt during inflation periods

is an advantage, debt permits the borrower to repay the lender in dollars that have declined in purchasing power.

Bonds, long-term notes, debentures, and capital leases belong in this category

liabilities

face value

the amount of money that a borrower must repay at maturity; also called par value or principal.

Issuance

the cash received when the bonds are issued (the issue or selling price)

maturity

the date on which a borrower agrees to pay the creditor the face (or par) value.

Interest

the interest payments

market rate

the market rate of interest demanded by creditors.

Interest amortization

the process used to determine the amount of interest to be recorded in each of the periods a liability is outstanding.

discount amortization formula

total discount/number of interest periods

debt to total assets ratio

total liabilities/total assets

Debt to Equity Ratio

total liabilities/total equity

premium amortization formula

total premium/number of interest periods

junk bonds

unsecured bonds where the risk of the borrower failing to make the payments is relatively high.

When bonds sell at a discount

when a bond sells at a price below face value, due to the yield being greater than the stated rate of interest. Interest expense > Interest Paid

When bonds sell at a premium

when a bond's selling price is above face value. Interest expense < Interest Paid

three basic cash flows

issuance: the cash received when the bonds are issued (the issue or selling price) interest: the interest payments repayment

lenders typically receive:

- periodic interest payments - repayment of the loan principal at some future date (loan maturity)

On a journal entry what do you do with Discount on Bonds payable?

Credit

On a journal entry what do you do with Premium on Bonds payable?

Debit

Is the total amount of interest expense over the life of the bond higher when we use straight-line amortization or the effective interest rate method?

Neither—the total amount of interest expense is identical under both methods. What changes is the interest expense allocated to each period

T or F, the way we account for Bonds and Notes are identical

True

Most bonds are known as

Unsecured bonds or debenture bonds

When bonds are issued at a premium, the interest expense for the period is the amount of interest payment for the period a. minus the premium amortization for the period b. plus the premium amortization for the period c. plus the discount amortization for the period d. minus the discount amortization for the period

a. minus the premium amortization for the period

The bond issue price is determined by calculating the a. present value of the stream of interest payments and the present value of the maturity amount b. future value of the stream of interest payments and the future value of the maturity amount c. future value of the stream of interest payments and the present value of the maturity amount d. present value of the stream of interest payments and the future value of the maturity amount

a. present value of the stream of interest payments and the present value of the maturity amount

In 2013, Drew Company issued $220,000 of bonds for $189,640. If the stated rate of interest was 6% and the yield was 6.73%, how would Drew calculate the interest expense for the first year on the bonds using the effective interest method? a. $189,640 x 8% b. $189,640 x 6.73% c. $200,000 x 8% d. $200,000 x 6.73%

b. $189,640 x 6.73%

Serenity Company issued $100,000 of 6%, 10-year bonds when the market rate of interest was 5%. The proceeds from this bond issue were $107,732. Using the effective interest method of amortization, which of the following statements is true? Assume interest is paid annually. a. Amortization of the premium for the first interest period will be $1,464 b. Amortization of the premium for the first interest period will be $613 c. Interest payments to bondholders each period will be $5,000 d. Interest payments to bondholders each period will be $6,464

b. Amortization of the premium for the first interest period will be $613

Which of the following statements regarding leases is false? a. If a lease is classified as a capital lease, the lessee records a lease liability on its balance sheet b. If a lease is classified as an operating lease, the lessee records a lease liability on its balance sheet c. Accounting recognizes two types of leases- operating and capital leases d. Lease agreements are a popular form of financing the purchase of assets because leases do not require a large initial outlay of cash

b. If a lease is classified as an operating lease, the lessee records a lease liability on its balance sheet

WVA Mining Company has leased a machine from Franklin Machinery Company. The annual payments are $6,000, and the life of the lease is 8 years. It is estimated that the useful life of the machine is 9 years. How would WVA record the acquisition of the machine? a. The machine would be recorded as an asset with a cost of $54,000 b. The machine would be recorded as an asset, at the present value of $6,000 for 8 years c. The machine would be recorded as an asset, at the present value of $6,000 for 9 years d. The company would not record the machine as an asset but would record rent expense of $6,000 per year

b. The machine would be recorded as an asset, at the present value of $6,000 for 8 years

Kinsella Corporation's balance sheet showed the following amounts: current liabilities, $75,000; total liabilities, $100,000, total assets, $200,000. What is the long-term debt equity ratio? a. 0.75 b. 0.375 c. 0.25 d. 0.125

c. 0.25

When bonds are issued by a company, the accounting entry typically shows an a. increase in liabilities and a decrease in stockholders' equity b. increase in assets and an increase in stockholders' equity c. increase in liabilities and an increase in stockholders' equity d. increase in assets and an increase in liabilities

c. increase in liabilities and an increase in stockholders' equity

McLauglin Corporation's balance sheet showed the following amounts: current liabilities, $75,000; total liabilities, $100,000; total assets, $200,000. What is the debt to total assets ratio? a. 2 b. 1 c. 0.875 d. 0.50

d. 0.50

Installment bonds differ form typical bonds in what way? a. Essentially they are the same b. The entire principal balance is paid off at maturity for installment bonds c. Installment bonds do not have a stated rate d. A portion of each installment bond payment pays down the principal balance

d. A portion of each installment bond payment pays down the principal balance

Bower co sold $100,000 of 20-year bonds for $95,000. The stated rate on the bonds was 7%, and interest is paid annually on Dec. 31. What entry would be made on December 31 when the interest is paid? a. Interest ExpenseCash b. Interest ExpenseBonds PayableCash c. Interest expenseDiscount on Bonds payableCash d. Interest ExpenseDiscount on Bonds payableCash

d. Interest ExpenseDiscount on Bonds payableCash

Repayment

the repayment of the principal (or face value)

leverage

the use of borrowed capital to produce more income than needed to pay the interest on a debt.