intermediate 2 - exam 1

Jones Company wants to improve its debt equity ratio and offers holders of convertible bonds additional consideration for converting their bonds to common stock. During 20X1, the company paid $500,000 for such consideration. This amount should be

recognized as an expense when paid.

An early extinguishment of debt refers to long-term liability such as bonds that are

retired prior to maturity

Common methods used by bond issuers to induce bond holders to convert their bonds to common stock are (Select all that apply.)

stock warrants additional cash favorable conversion ratios

In a troubled debt restructuring with modified terms, if total cash payments are less than the book value of the debt,

the difference is recorded as a gain in net income.

Accounting for troubled debt restructuring with modified terms depends on whether under the new agreement,

total cash payments are more or less than the book value of the debt

restructuring refers to a change in the original terms of a debt agreement that is motivated by the financial difficulties of the borrower.

troubled debt

The result of changes in the original terms of a debt agreement that are motivated by financial difficulties experienced by the debtor are referred to as

troubled debt restructuring.

Nattel Corp. issues 10,000, $1,000 face amount bonds at 104. Each bond can be converted into 25 shares of no-par common stock. Two years after issuance, 25% of the bondholders convert their bonds. The balance in the premium on bonds payable account is $300,000. Nattel should recognize this conversion by crediting common stock for

$2,575,000 Reason: (10,000 x 1,000 + 300,000) x 25%

Evergreen Corp. issues 10,000, $1,000 face amount bonds. Each bond can be converted into 20 shares of common stock. At the bond issue date, the company's common shares trade for $55 per share. At the date of issue, Evergreen should recognize an addition to equity of

$1,000,000. Reason: (55 - 50) x 10,000 x 20 shares

Leslie Corp. is experiencing financial difficulties and is unable to meet the terms of its $2 million note. Currently, the company also owes $200,000 in unpaid interest. The lender agrees to forgive part of the principal and to decrease the interest rate substantially. The lender's accountant determines that the future cash payments total $1.8 million. On the date of restructuring, Leslie should recognize

a gain on debt restructuring of $400,000

Gruenwald Corp. issues 10,000, $1,000 face amount bonds. Each bond can be converted into 25 shares of common stock. At the bond issue date, the company's common shares trade for $44 per share. At the date of issue, Gruenwald should recognize an addition to equity of

$1,000,000. Reason: $1000/25 shares = $40 per share conversion price (44 - 40) x 10,000 x 25 shares

For bonds issued with detachable stock warrants, the issue price is:

allocated between debt and equity

Mitchell's investment in convertible bonds has a net book value of $1.4 million when Mitchell converts the bonds to common stock. The fair value of the common stock is $1.5 million. Mitchell should recognize its investment in common stock at

$1.4 million

On April 1, Magenta Company sells $500,000 face amount, 10% bonds. The bonds pay interest semi-annually on June 30 and December 31. The effective rate for this company is 9%. When the bonds are issued, how much interest will be included in the issue price?

$12,500 correct Reason: The price includes accrued interest of 500,000 x 10% x 3/12

Accounting for convertible bonds subsequent to issuance is the same as accounting for

non-convertible bonds

If a company elects the fair value option for its bonds, related gains and losses that arise from changes to credit risk are reported as:

other comprehensive income

If bonds sell between interest periods, the amount received by the bond issuer includes the bonds selling price

plus accrued interest.

Nattel Corp. issues 10,000, $1,000 face amount bonds at 104. Each bond can be converted into 25 shares of no-par common stock. Two years after issuance, 25% of the bondholders convert their bonds. The balance in the premium on bonds payable account is $300,000. Nattel should debit

premium on bonds payable for $75,000. bonds payable for $2,500,000.

If bonds are not traded on an open-market exchange, their fair value can be estimated as the

present value of the remaining future cash flows discounted at the current interest rate.

The primary purpose of the call feature associated with bonds is to

protect the issuer against declining interest rates.

Which of the following are common strategies for debtors to retire bonds prior to the maturity date? (Select all that apply.)

Including a call feature when the bonds are issued. Purchasing bonds on an open market.

Which of the following statements regarding the fair value option is correct?

It can be applied on an "instrument-by-instrument" basis.

Munster Company's bonds have increased in fair value and Munster records a gain. This indicates that Munster

elected the fair value option

A conversion feature is "beneficial" if the stock into which the bond can be converted

exceeds the face amount of the bond.

Assets that are used to satisfy troubled debt are valued at

fair value

True or false: If a company elects the fair value option, it must report all of its financial instruments at fair value.

false

Common methods used by bond issuers to induce bond holders to convert their bonds to common stock are

favorable conversion ratios additional cash stock warrants

Southfield Company reached an agreement with its bank to transfer a piece of land with a historical cost of $500,000 and a fair value of $1.2 million to the bank in full settlement of its outstanding loan principal plus accrued interest of $1.5 million. Prior to the transfer, Southfield should credit

gain on disposal of land for $700,000 correct Reason: the land will be value at fair value prior to transfer

When trouble debt is modified and the cash payments exceed the amount owed,

interest is recorded at a new, lower effective rate.

On May 1, Early Company sells $500,000 face amount, 12% bonds. The bonds pay interest semi-annually on June 30 and December 31. The effective rate for this company is also 12%. When the bonds are issued, Early will credit (Select all that apply.)

interest payable for $20,000. bonds payable for $500,000.

The fundamental reason why companies issue convertible bonds is to

make the bonds more attractive to investors.

Changes in the current often represent a major contributor to changes in the fair value of bonds.

market interest rate

Nattel Corp. issues 10,000, $1,000 face amount bonds at 104. Each bond can be converted into 25 shares of no-par common stock. Margarita, Inc., purchased 2,500 of the bonds and converts them after 2 years. At that time, the balance in the premium on bond investment is $75,000. Margarita should recognize this conversion by debiting investment in common stock for

$2,575,000 Reason: (2,500 x 1,000) + 75,000

On January 1, MLK Corp. issued $10 million of 8% bonds at 104. Each $1,000 bond is accompanied by 25 stock warrants. Each warrant permits the holder to purchase one share of no-par common stock for $20. Immediately after issuance, the warrants were listed on the stock exchange for $2 each. MLK should recognize equity from the sale of bonds of

$500,000. Reason: $2 x 25 x 10,000

On May 1, Early Company sells $500,000 face amount, 12% bonds. The bonds pay interest semi-annually on June 30 and December 31. The effective rate for this company is also 12%. When the bonds are sold, Early will receive cash in amount of

$520,000. correct Reason: These bonds are sold between interest payment dates so the price includes accrued interest since the last interest date. (500,000 x 12% x 4/12) + 500,000

On April 1, Munchin Company sells $800,000 face amount, 6% bonds. The bonds pay interest semi-annually on June 30 and December 31. The effective rate for this company is also 6%. When the bonds are sold, Munchin should receive:

$812,000 Reason: These bonds are sold between interest payment dates so the price includes accrued interest since the last interest date. $800,000 + ($800,000 x 0.06 x 3/12)

Which of the following statements regarding convertible bonds subsequent to issuance is correct?

Accounting is the same as for nonconvertible bonds.

Leslie Corp. is experiencing financial difficulties and is unable to meet the terms of its $2 million note. Currently, the company also owes $200,000 in unpaid interest. The lender agrees to forgive part of the principal and to decrease the interest rate substantially. The lender's accountant determines that the future cash payments total $1.8 million. How should the debtor recognize subsequent interest payments?

As a reduction of the outstanding loan balance

True or false: Holding gains resulting from decreases in the fair value of debt indicate that the company's debt has become less risky.

False

Which of the following is correct regarding the recognition of the value of a conversion feature associated with a convertible bond?

The value of the conversion feature is not recognized separately.

Which of the following is correct regarding the recognition of the value of a conversion feature associated with a convertible bond consistent with IFRS?

The value of the conversion feature is recognized as equity.

Which of the following represents an important difference between bonds with detachable warrants and convertible bonds?

The warrants can be separated from the bonds.

Which of the following are true regarding bonds sold with detachable warrants?

The warrants can be sold by the bondholder to another investor. The warrants can be exercised separately from the bonds.

Which of the following are among the most important reasons why companies issue convertible instead of nonconvertible bonds?

To sell the bonds at a higher price. To enable smaller or debt-heavy companies to gain access to the bond market. To use a medium of exchange in mergers and acquisitions.

Walker Corp. issues $10 million in bonds at a discount. One year later, the unamortized discount associated with the bonds is $325,000. The company chose the fair value option; however, because of private placement, the fair value is not readily observable. As an alternative, the company

can report the bonds at the present value of the remaining cash flows using the current effective rate.

Which of the following is a common factor that affects the fair value of a company's bonds?

changes in current market rates

A bond feature that aims at making the bonds more attractive to investors is the ______ feature.

conversion

Bonds that can be exchanged for shares of stock at the option of the bondholder are referred to as

convertible bonds

Wasser Company issues $500,000, 8% convertible bonds for $510,000. Without the conversion feature, the bonds would issue at par. Consistent with IFRS, on the date of issuance Wasser should

credit equity-conversion option for $10,000.

Wasser Company issues $500,000, 8% convertible bonds for $510,000. Without the conversion feature, the bonds would issue at par. On the date of issuance, Wasser should

credit premium on bonds payable for $10,000.

The risk that bond investors will not receive interest and principal payments when they are due is referred to as:

credit risk

The risk that bondholders will not receive interest and principal payments when due is

credit risk

Volk Company selected the fair value option for its outstanding bonds. During the current year, the company recognized a holding gain relating to the bonds in income. The holding gain is a result of the value of the bonds

decreasing