ACG Exam 4

Formula for straightline method of bond discount amortization

Bond discount / # of interest periods (Discount on Bonds Payable) Bond Premium / # of Interest Periods (Premium on Bonds Payable)

On January 1, Pierce Corporation issues $500,000, 5-year, 12% bonds at 96 with interest payable on January 1. What is the carrying value of the bonds at the end of the third interest period if amortization is $4,000 per year using the straight-line amortization method?

After three interest periods, the carrying value of the bonds will have increased by three times the annual discount amortization of $4,000, or a total of $12,000. The original carrying value of $480,000 plus the three years of discount amortization amounts to $492,000 as the carrying value at the end of the third interest period.

Glass Company received proceeds of $445,000 on 10-year, 8% bonds issued on January 1, 2016. The bonds had a face value of $400,000, pay interest annually on December 31st, and have a call price of 101. Glass uses the straight-line method of amortization. What is the carrying value of the bonds on January 1, 2019?

Amortization per year = ($445,000 - 400,000)/10 years = $4,500 per year Remaining premium after three years = $45,000 - (4,500 x 3) = $31,500 Carrying value of bonds = Face value of bonds + premium on bonds - discount on bonds Carrying value after three years = $400,000 + 31,500 = $431,500

payout ratio

cash dividends declared on common stock / net income

Brown Box Inc. issues a $1,000,000, 11%, 20-year mortgage note. The terms provide for annual installment payments of $125,576. What is the remaining unpaid principal balance of the mortgage payable account after the first annual payment?

Solution: Since interest accrues annually, the first year's interest would be $110,000 (i.e., 11% x $1,000,000) which equals the annual interest rate times outstanding mortgage principal as of the beginning of the first annual period. The mortgage principal is reduced by the difference between the $125,576 payment and the interest component ($110,000), resulting in a principal reduction of $15,576. Thus, the first annual mortgage payment reduces the outstanding mortgage principal balance by $15,576 from $1,000,000 to $984,424.

On January 1, $5,000,000, 10-year, 10% bonds were issued at $5,200,000. Interest is paid semi-annually each January 1 and July 1. The straight-line method of amortization is used to amortize the premium. How much is the first semi-annual amortization?

The premium is amortized or is divided equally over the 10-year term of the bonds. The issue price of the bonds less the face amount of the bonds is the amount of the premium. When the premium of $200,000 is divided by the total semiannual interest payment periods, the result is amortization of $10,000 per interest payment period.

Green Tree Inc. sells 10%, 10-year bonds with a face value of $100,000 for $102,000. Using the effective-interest amortization method, how much is the interest expense for the first year if the effective interest rate is 9.47%?

Using the effective-interest method, the bond interest expense equals the effective interest rate times the bond's carrying value: 9.47% x $102,000 = $9,659.40.

On January 1, Forever Ceramics issued $1,000,000, 9% bonds for $939,000. This price resulted in an effective interest rate of 10% on the bonds. Interest is payable annually on January 1. The company uses the effective-interest method of amortizing bond discount. At the end of the first year, how much should Forever Ceramics report as unamortized bond discount?

Using the effective-interest method, the bond interest expense equals the effective interest rate times the bonds' carrying value. The cash paid is the contractual or stated interest rate times the face amount of the bonds. The difference is the amount of premium or discount amortized for the year. The original discount is $61,000 ($1,000,000 - $939,000). The amortization for the first year is equal to the difference between the cash interest to be paid ($1,000,000 x 9% = $90,000) and interest expense ($939,000 x 10% = $93,900), or $3,900. The amortization of $3,900 is subtracted from the original discount of $61,000 to arrive at the unamortized bond discount at the end of the first year of $57,100.

Face value

amount of principal due at the maturity date of the bond

convertible bonds

bonds that can be converted into common stock

secured bonds

bonds that have specific assets of the issuer pledged as collateral

callable bonds

bonds that the issuing company can redeem at a state dollar amount prior to maturity

bond interest expense formula

carrying value of bonds at beginning of period x effective interest rate

current ratio

current assets/ current liabilities

discount on bonds payable is a _____________ account

debit

which one does GAAP require, effective or straightline?

effective rate of interest method

bond interest paid formula

face amount of bond x contractual interest rate

interest paid in cash equation

face value times teh contractuel

Interest to be paid

face value x bonds stated interest rate

the effect of amortizing a bond discount is that it

increases the carrying value of the bonds

interest expense

interest to be paid mnius premium amortization

Times interest earned

net income + interest expense + tax expense / interest expense

earnings per share

net income - preferred dividends / avg common shares outstanding

return on common stockholders equity

net income - preferred dividends / avg common stockholders equity

premium amortization

premium/amortization period

the nature of a bond premium is that it

reduces the cost of borrowing

Maturity date

the date on which the final payment on a bond is due from the bond issuer to the investor

Discount on a bond

the difference between the face value of a bond and its selling price when a bond is sold for less than its face value

premium on a bond

the difference between the selling price and the face value of a bond when a bond is sold for more than its face value

if a bond is issued at premium interest expense includes

the interest paid in the form of cash minus the amortization of the premium

if a bond is issued at a discount, interest expense includes

the interest paid in the form of cash plus the amortization of the discount

present value

the value today of an amount to be received at some date in the future after taking into account current interest rates

debt to assets ratio

total liabilities/ total assets

Computation of amortization using the effective interest method

{Carrying value of bonds at beginning of period x effect interest rate} - {face amount of bond -contractual interest rate} = amortization amount