ACC 318 CH 14

The present value of its future interest and principal cash flows is used to calculate the ________ payable.

value of a note

Your friend Juan tells you that he has run across what he believes to be a fantastic investment opportunity. Specifically, he has learned that XYZ Corporation is planning a deep-discount debenture bond issue in the coming months. The low price of this bond appeals to Juan, especially in light of the bond's high face value and above-average interest rate. Juan asks your advice on whether he should purchase one of these bonds. Which of the following represents your best response?

"Your decision depends on whether you want this bond to provide an income stream prior to its maturity date. If you are interested in receiving regular cash flows, this bond is not your best choice."

Albany Enterprises uses the fair value option to value its bonds payable. Last year, the firm experienced a moderate decline in its credit rating. If interest rates remained constant over that same period, which of the following entries would you expect to see recorded in Albany's books

A debit to the Bonds Payable account and a credit to the Unrealized Holding Gain or Loss—Income account

On January 1, 2020, Ryan Corp. issued 2,000 of its 10%, $1,000 bonds for $2,080,000. These bonds were to mature on January 1, 2030 but were callable at 101 any time after December 31, 2023. Interest was payable semiannually on July 1 and January 1. On July 1, 2025, Ryan called all of the bonds and retired them. Bond premium was amortized on a straight-line basis. Before income taxes, which of the following is Ryan's gain or loss in 2025 on this early extinguishment of debt?

ANS: $16,000 gain The net carrying value of the bonds is $2,080,000, but the face value is only $2,000,000 (2,000*$1,000). Therefore, the total amount to be amortized as a premium is $80,000 ($2,080,000 - $2,000,000). To find the amount per period to be amortized, divide $80,000 by the number of periods (10 years * 2 periods/year = 20 periods), or $80,000/20 =$4,000. This particular bond has accrued over the period of 5.5 years, or 11 periods, so $4,000 X 11 = $44,000. Then subtract this number from the amount received at the time of issuance: $2,080,000 - $44,000 = $2,036,000. This is the carrying value at the time of recall. Next find the repurchase price: $2,000,000 X 1.01 = $2,020,000 and subtract this from the net carrying value: $2,036,000 - $2,020,000 = $16,000. Because they paid less than the carrying value, they report a gain of $16,000.

Jolly Industries issued a $1.8 million note payable to Beckman Construction in exchange for construction services. Similar notes have an interest rate of 12 percent. Beckman Construction plans to construct the building with equal costs over the life of the note, thus equaling three annual payments of $600,000. What should Beckman record as their Discount on Notes Payable when the note is issued? Assume that the PVF-OA3, 10% = 2.48685, PVF-OA3, 12% = 2.40183, PVF3, 10% = 0.75131, and PVF3, 12% = 0.71178.

ANS: $358,902 The present value of three annual payments of $600,000 at 12% interest is $600,000 * 2.40183 (PVF-OA3, 12%)= $1,441,098. Therefore, the discount is $1,800,000 - $1,441,098 = $358,902.

In 2020, Noll Industries had a net income of $320,000, interest expense of $65,000, and a times interest earned ratio of 7. What was Noll's income before taxes for the year?

ANS: $390,000 Times earned interest ratio is calculated by (Net income + income taxes + interest expense)/interest expense. Therefore, times earned interest (7) * interest expense ($65,000) = net income + income taxes + interest expense = $455,000. The net income before taxes would be equal to $455,000 - interest expense ($65,000) = $390,000.

On June 30, 2020, Canton Industries had outstanding 8%, $6,000,000 face amount, 15-year bonds maturing on June 30, 2035. Interest is payable on June 30 and December 31. The unamortized balances in the bond discount and deferred bond issue costs accounts on June 30, 2020 were $210,000 and $60,000, respectively. On June 30, 2020, Canton acquired all of these bonds at 94 and retired them. The net carrying amount that should be used in computing gain or loss on this early extinguishment of debt is

ANS: $5,730,000. The net carrying amount that can be used to compute gain or loss can be found by first adding together the bond issue costs: $210,000 + $60,000 = $270,000. Then subtract this amount from the face amount: $6,000,000 - $270,000 = $5,730,000 net carrying amount.

Reardon Pharmaceuticals issued a $2.7 million note payable to Nagel Chemicals in exchange for chemical products. Similar notes have an interest rate of 8 percent. Nagel Chemicals plans to pay Reardon in chemicals equally over the five years, thus equaling five annual payments of $540,000. What should Nagel record as their Discount on Notes Payable when the note is issued? Assume that the PVF-OA5, 6% = 4.21236, PVF-OA5, 8% = 3.99271, PVF5, 6% = 0.74726, and PVF5, 8% = 0.68058.

ANS: $543,936.60 The present value of five annual payments of $540,000 at 8% interest is $540,000 * 3.99271 (PVF-OA5, 8%) = $2,156,063.40. Therefore, the discount is $2,700,000 - $2,156,063.40 = $543,936.60

The 10% bonds payable of Yano Company had a net carrying amount of $950,000 on December 31, 2020. The bonds, which had a face value of $1,000,000, were issued at a discount to yield 12%. The amortization of the bond discount was recorded under the effective-interest method. Interest was paid on January 1 and July 1 of each year. On July 2, 2021, several years before their maturity, Yano retired the bonds at 102. The interest payment on July 1, 2021 was made as scheduled. Ignoring taxes, the loss that Yano should record on the early retirement of the bonds on July 2, 2021 is

ANS: $63,000. First, take the carrying value of the bonds at the market interest rate (bond interest expense) and subtract bond interest paid to find the amortized amount. In this case, the carrying amount is $950,000 with an effective interest rate of 12%. However, interest is paid semiannually, so all interest rates should be adjusted for semiannual payments. Therefore, the bond interest expense is $950,000 X 12% x 1/2 = $57,000. The bond interest paid is the face value x stated interest rate x time period or ($1,000,000 x 10% x 1/2) or $50,000. The amortized amount is $7,000 ($57,000 - $50,000). The new carrying amount is then $950,000 + $7,000 = $957,000. Next, find the repurchase price $1,000,000 X 1.02 = $1,020,000. Finally, subtract the purchase price from the carrying amount: $1,020,000 - $957,000 = $63,000 loss on retirement of bonds.

Ruffin Dog Supplies issued a $60,000, four-year note payable to Dozier Resources in exchange for cash. The note was issued at 8%, but notes with similar risk have an interest rate of 6 percent. Ruffin is expected to make four annual interest payments of $4,800 with one lump-sum payment for the principal at the end of Year 4. How much cash will Ruffin receive on the date the note was issued? Assume that the PVF-OA4, 6% = 3.46511, PVF-OA4, 8% = 3.31213, PVF4, 6% = 0.79209, and PVF4, 8% = 0.73503.

ANS: $64,157.93 The present value of the principle is $60,000 * 0.79209 (PVF4, 6%) = $47,525.40. The present value of the interest payments is $4,800 * 3.46511 (PVF-OA4, 6%) = $16,632.53. Therefore, Ruffin should receive $47,525.40 + $16,632.53 = $64,157.93.

Turk Industries has the following included in their liabilities: 1. 10-year, $100,000 loan at 8% interest, payable at $10,000/year plus interest, obtained in 2012 2. Five-year term bond with $750,000 par value at 9% interest, issued in 2016 3. Eight-year term bond with $500,000 par value at 5% interest, issued in 2017 4. 20-year, $2 million loan at 6% interest, payable at $100,000/year plus interest, obtained in 2018 How much of these liabilities, excluding interest, will they list under current liabilities at 12/31/20?

ANS: $860,000 For the 10-year loan, they will have current liabilities of $10,000. For the 20-year loan, they will have current liabilities of $100,000. For the eight-year term bond, they will have no current liabilities. For the five-year term bond, they will have current liabilities of $750,000. This gives total current liabilities of $860,000 ($10,000 + $100,000 + $750,000).

An early extinguishment of bonds payable, which were originally issued at a premium, is made by purchase of the bonds between interest dates. Which of the following is not true at the time of reacquisition? - Any costs of issuing the bonds must be amortized up to the purchase date - Interest must be accrued from the last interest date to the purchase date - The premium must be amortized up to the purchase date - Any gain or loss is amortized over the remaining life of the bonds

Any gain or loss is amortized over the remaining life of the bonds

The net _________ is the amount payable at maturity of the bonds less the cost of issuance and any discounts, plus any premiums.

Carrying

The 12% bonds payable of Tegan Industries had a carrying amount of $3,120,000 on December 31, 2020. The bonds, which had a face value of $3,000,000, were issued at a premium to yield 10%. Tegan uses the effective-interest method of amortization. Interest is paid on June 30 and December 31. On June 30, 2021, several years before their maturity, Tegan retired the bonds at 104 plus accrued interest. Ignoring taxes, which of the following is the loss on retirement?

First, take the carrying value of the bonds at the market interest rate (bond interest expense) and subtract bond interest paid to find the amortized amount. In this case, the carrying amount is $3,120,000 with an effective interest rate of 10%. However, interest is paid semiannually, so all interest rates need to be adjusted for semiannual payments. So, the bond interest paid per period is $180,000 ($3,000,000 X 12% x 1/2). The bond interest expense for at June 30 would be computed as follows: $3,120,000 x 10% x ½ = $156,000.The amortized amount is $24,000 ($180,000 - $156,000). The new carrying amount is then $3,120,000 - $24,000 = $3,096,000. Next, find the repurchase price $3,000,000 X 1.04 = $3,120,000. Finally, subtract the purchase price from the carrying amount: $3,120,000 - $3,096,000 = $24,000 loss on retirement.

Kemper Sports is a subsidiary of Meador Enterprises. Meador owns 49% of Kemper's stocks. Other individual outside investors hold no more than 3% of Kemper's stocks. Because Meador owns less than 50% of the stock, they do not report Kemper's assets or debts on their balance sheet. Due to several poor years economically, Kemper has been forced to go out of business. The sale of their assets is only enough to cover 63% of their debt. Who do you expect may be responsible for paying the remaining 37% of the debt?

Meador Enterprises

Which of the following is not something that needs to be determined to find the loss on redemption? - Stated interest rate - Unamortized discount - Unamortized issue cost - Reacquisition price

Stated interest rate

Amador Incorporated signed a long-term mortgage note to provide funds to build a new building. The note was secured by the title to the building. If Amador is expected to pay the bank $90,000 per year for 10 years to repay the loan, which of the following relationships can you expect to apply to the situation? - The balance of Mortgage Payable will remain a constant amount over the 10-year period. - The balance of Mortgage Payable will decrease over the 10-year period. - The amount of interest expense will remain constant over the 10-year period. - The balance of Mortgage Payable at a given balance sheet date will be reported as a long-term liability.

The balance of Mortgage Payable will decrease over the 10-year period.

Peninsula Products has just applied for a loan at your bank. When reviewing Peninsula's books for the year that just ended, you notice that the firm uses the fair value option for its bonds payable. You also see that the firm recorded a $55,000 debit in its Bonds Payable account and a $55,000 credit in its Unrealized Holding Gain or Loss—Income account. Over that same period, interest rates decreased by about 0.5 percent. How should this information affect the bank's decision as to whether to grant Peninsula a loan?

The bank should hesitate before giving a loan to Peninsula because the changes in firm's Bonds Payable and Unrealized Holding Gain or Loss—Income accounts suggest that Peninsula has seen a decline in its credit rating over the past year.

If a bond is held to maturity, then the carrying amount and face value will have which of the following relationships? - The carrying amount will equal the face value. - The carrying amount will be greater than the face value. - The carrying amount will be less than the face value. - The carrying amount will be greater than or equal to the face value.

The carrying amount will equal the face value

Marci's company has a bond with a face value of $56,000. When the bond sells, the selling price is $57,400. Marci considers the sale to be acceptable. What occurred as a result of this sale? - The effective yield was lower than the stated rate. - The interest rate was higher than expected. - No interest rate was issued. - The effective yield exceeded the stated rate.

The effective yield was lower than the stated rate

Which of the following is representative of refunding?

The replacement of an existing issuance with a new one

Which of the following scenarios would be most beneficial for a firm's shareholders, assuming overall interest rates remain constant and the firm uses the fair value option to value its bonds?

The value of the firm's bonds payable decreases while the value of its assets remains constant.

Vergara Enterprises is the parent company of Seibert Incorporated and owns 49% of the company. Therefore, Vergara does not report their affiliation with Seibert on their balance sheet. Seibert Incorporated has a 75:25 debt-to-equity ratio, and the fair value of all their assets is currently not enough to cover their debt. If Seibert goes under and is immediately obligated to pay their debts, who do you expect may be responsible for paying the debts that Seibert cannot pay?

Vergara Enterprises