accounting chapter 10

4. A company issued five-year, 5% bonds with a par value of $100,000. The company received $95,735 for the bonds. Using the straight-line method, the company's interest expense for the first semiannual interest period is a. $2,926.50. b. $5,853.00. c. $2,500.00. d. $5,000.00. e. $9,573.50.

4. a; Cash interest paid = $100,000 × 5% × ½ year = $2,500 Discount amortization = ($100,000 - $95,735)/10 periods = $426.50 Interest expense = $2,500.00 + $426.50 = $2,926.50

5. A company issued eight-year, 5% bonds with a par value of $350,000. The company received proceeds of $373,745. Interest is payable semiannually. The amount of premium amortized for the first semiannual interest period, assuming straight-line bond amortization, is a. $2,698. b. $23,745. c. $8,750. d. $9,344. e. $1,484.

5. e; ($373,745 - $350,000)/16 periods = $1,484

2. A bondholder that owns a $1,000, 6%, 15-year (term) bond has a. The right to receive $1,000 at maturity. b. Ownership rights in the bond-issuing entity. c. The right to receive $60 per month until maturity. d. The right to receive $1,900 at maturity. e. The right to receive $600 per year until maturity

A

10.A total of $100,000 of 6%, 10-year bonds, with semiannual interest are sold at 98. What is the amount of periodic bond discount amortization using the straight-line method? A) $100 B) $10,000 C) $200 D) $9,900 E) None of the above

A) $100 Feedback: The amount of the discount of $2,000 (or $100,000 x 2% (or 100% - 98%)) divided by the number of interest periods of 20 (or 2 times per year x 10 years) equals periodic bond discount amortization of $100. (Learning Objective P2)

7. When bonds are quoted at "95", which of the following is true? A) The bonds are being sold at 95% of their par value. B) The bonds are being sold at 95% of the maturity value. C) The bonds are being sold at a 5% premium. D) All of the above. E) None of the above.

A) The bonds are being sold at 95% of their par value. Feedback: When bonds are quoted at "95," the bonds are being sold at 95% of their par value. (Learning Objective P1)

1. A bond traded at 97½ means that a. The bond pays 97½% interest. b. The bond trades at $975 per $1,000 bond. c. The market rate of interest is below the contract rate of interest for the bond. d. The bonds can be retired at $975 each. e. The bond's interest rate is 2½%.

B

12.When $100,000 of 6% annual interest, 10-year bonds are sold at 103.5, what will be the total interest expense on the bonds? A) $ 6,000 B) $56,500 C) $60,000 D) $63,500 E) None of the above

B) $56,500 Feedback: The total interest expense can be determined by subtracting the amount of the premium from the result of multiplying the annual interest by the number of periodic interest payments ($100,000 x 0.06 x 10). The total interest expense is $60,000 - $3,500 = $56,500. (Learning Objective P3)

2. Which of the following is false? A) Both IFRS and U.S. GAAP allow companies to account for bonds and notes using fair value. B) Fair value of bonds is the same as the amortized value described in this chapter. C) Both IFRS and U.S. GAAP require companies to distinguish between operating leases and capital leases. D) Both IFRS and U.S. GAAP require companies to record costs of retirement benefits as employees work and earn them. E) All of the above.

B) Fair value of bonds is the same as the amortized value described in this chapter. Feedback: Fair value of bonds is different from the amortized value described in this chapter. (Learning Objective Global View)

what kind of interest do bonds pay?

Bonds pay a stated rate of interest that may be different from the market rate of interest when the bonds are issued.

debenture bonds

Bonds that are unsecured (i.e., not backed by any collateral such as equipment).

convertible bonds

Bonds that can be converted into common stock at the bondholder's option

secured bonds

Bonds that have specific assets of the issuer pledged as collateral.

3. A company issues 8%, 20-year bonds with a par value of $500,000. The current market rate for the bonds is 8%. The amount of interest owed to the bondholders for each semiannual interest payment is a. $40,000. b. $0. c. $20,000. d. $800,000. e. $400,000.

C 500000 x 0.08 x 1/2=20000

1. Which of the following describes a disadvantage of bonds? A) The interest on bonds is tax deductible. B) Bonds can increase return on equity. C) Bonds require payment of periodic interest and maturity value. D) Bonds do not affect stockholder control. E) None of the above.

C) Bonds require payment of periodic interest and maturity value.Feedback: There are two major disadvantages of bonds: (1) bonds can decrease return on equity (when a company earns a lower return with the borrowed funds than it pays in interest), and (2) bonds require payment of both periodic interest and the par value at maturity. Advantages of bonds include (1) bonds do not affect owner control, (2) interest on bonds is tax deductible, and (3) bonds can increase return on equity (when the company earns a higher return with borrowed funds than it pays in interest on those funds). (Learning Objective A1)

15. Lack-Luster Corporation borrowed money by issuing a $100,000 installment note payable that required $10,000 annual payments plus interest of 12% on the unpaid balance prior to the payment. What was the interest expense at the end of the third year? A) $8,400 B) $7,200 C) $9,600 D) $18,400 E) None of the above

D) $18,400 Feedback: The unpaid balance at the end of the third year, prior to payment, is $80,000 (or $100,000 - ($10,000 X 2)). The interest expense would be 12% x $80,000 = $9,600. (Learning Objective P5)

8.The straight-line method of amortizing bond discounts and premiums results in which of the following? A) An equal portion of bond interest expense is charged to each period. B) The discount or premium account is reduced to zero by the end of the bond's life. C) The Interest Expense account is debited when a discount is amortized; alternatively, the Interest Expense account is credited when a premium is amortized. D) All of the above. E) None of the above.

D) All of the above. Feedback: When the straight-line method is used, choices A, B, and C are correct statements. (Learning Objectives P2 and P3)

5.A company issues $400,000 of 8% bonds, which mature in 10 years, at par on January 1, 2011. The bonds pay interest semiannually on each June 30 and December 31. What entry should be made on December 31, 2009? A) Debit Bond Interest Expense $32,000; Credit Bond Interest Payable $32,000. B) Debit Bond Interest Expense $32,000; Credit Cash $32,000. C) Debit Bond Interest Expense $16,000; Credit Bond Interest Payable $16,000. D) Debit Bond Interest Expense $16,000; Credit Cash $16,000. E) None of the above

D) Debit Bond Interest Expense $16,000; Credit Cash $16,000. Feedback: A semiannual interest payment must be made on December 31, 2009. The following entry will be recorded: debit Bond Interest Expense for $16,000 (or $400,000 x .08 x 6/12) and credit Cash for $16,000. (Learning Objective P1)

9.Which of the following statements are not correct regarding bonds sold at a discount? A) The carrying amount gets larger each year. B) The Discount on Bonds Payable account gets smaller each year. C) At maturity, the face value and carrying value will be equal. D) The balance of Bonds Payable account will get larger each year. E) At maturity, the balance of the Discount on Bonds Payable will be zero.

D) The balance of Bonds Payable account will get larger each year. Feedback: When bonds are sold at a discount, the carrying amount (which equals the par value less the unamortized discount) gets larger each year. The Discount on Bonds Payable account is reduced to zero over the life of the bonds; as such, the account balance gets smaller (rather than larger) each year and, at maturity, the face (or par) value and the carrying value will be equal. (Learning Objective P2)

11. When $500,000 of 2-year, 8% bonds that pay interest semiannually are sold when the market rate of interest is 12%, which of the following lines describes the calculation of the selling price of the bonds? (Refer to the present value tables in your textbook as needed.) A) (0.7921 x $500,000) + (3.4651 x $30,000) = bond selling price B) (0.7972 x $500,000) + (3.3121 x $30,000) = bond selling price C) (0.7972 x $500,000) + (3.4651 x $50,000) = bond selling price D) (0.8900 x $500,000) + (1.8334 x $50,000) = bond selling price E) (0.7921 x $500,000) + (3.4651 x $20,000) = bond selling price

E) (0.7921 x $500,000) + (3.4651 x $20,000) = bond selling price Feedback: Since interest is paid semiannually, i = 6% (or the market rate of 12% divided by 2) and n, the number of interest periods, equals 4 (or 2 times per year multiplied by the 2 year-life); i = 6% and n = 4 are used to determine the present value factors. The present value of $1 table is used to compute the present value the par value of the bond. The present value of an annuity of $1 table is used to compute the present value the series of semiannual interest payments. The selling price of the bonds equals (1) the present value of the bonds' par value (determined by multiplying the par value of $500,000 by the related present value of $1 factor of 0.7921) plus the present value of the semiannual interest payments (determined by multiplying the semiannual payments of $20,000 (or $500,000 multiplied by the contract rate of 8% multiplied by 1/2 year) by the present value of an annuity of $1 factor of 3.4651). (Learning Objective P2)

13.Bonds with a par value of $100,000 and a carrying value of $103,600 are retired at a call price of $101,000. The journal entry to retire the bonds would include which of the following? A) A credit to the Cash account for $101,000 B) A debit to the Bonds Payable account for $100,000 C) A credit to the Gain on Retirement of Bonds account for $2,600 D) A debit to the Premium on Bonds Payable account for $3,600 E) All of the above

E) All of the above Feedback: The journal entry to retire the bonds would include a debit to the Bonds Payable account of $100,000; a debit to the Premium on Bonds Payable account of $3,600 (or $103,600 - $100,000); a credit to the Cash account of $101,000; and a credit to the Gain on Retirement of Bonds account of $2,600 (or $103,600 - $101,000). (Learning Objective P4)

6. Which of the following statements is correct regarding the issuance of bonds at par? A) The proceeds for bonds issued at par equals the par value of the bond. B) The stated interest rate equals the market interest rate for bonds issued at par. C) When bonds are issued at par, the Cash account is debited and the Bonds Payable account is credited for the bonds' par value. D) On each semiannual interest payment date, bond interest expense is calculated as bond par value multiplied by the bond contract rate multiplied by 1/2 year. E) All of the above.

E) All of the above. Feedback: All of the above statements are correct regarding bonds sold at par. (Learning Objective P1)

3. Which type of bond gives the issuing corporation the option of retiring the bond, at a predetermined price, prior to the bond's maturity date? A) Debenture B) Convertible bond C) Serial bond D) Secured bond E) Callable bond

E) Callable bond Feedback: A callable bond has an option exercisable by the issuer to retire the bonds at a stated dollar amount prior to maturity. (Learning Objective A2)

4. The debt-to-equity ratio is 6.0. If total equity is $10,000, what is the amount of total liabilities? A) $600,000 B) $6,000 C) $100,000 D) $60,000 E) None of the above

Feedback: The debt-to-equity ratio is computed by dividing total liabilities by total equity. Letting X represent total liabilities, X divided by total equity of $10,000 = 6.0 (or, X = $10,000 x 6 = $60,000). (Learning Objective A3)

carrying Value > Retirement Price =

Gain

Major disadvantages of using bonds

The major disadvantages resulting from the use of bonds are that interest must be paid on a periodic basis and the principal (face value) of the bonds must be paid at maturity.

bond indenture

The terms of the bond issue are set forth in a legal document .In addition to the terms, the indenture summarizes the rights of the bondholders and their trustees, as well as the obligations of the issuing company.

How are transactions between a bondholder and other investors recorded in the journal?

Transactions between a bondholder and other investors are not journalized by the issuing corporation. A corporation only makes journal entries when it issues or buys back bonds, and when bondholders convert bonds into common stock.

3 advantages bonds have over common stock

a. Stockholder control is not affected. b. Tax savings result. c. Earnings per share on common stock may be higher.

How are bond prices quoted?

as a percentage of face value (usually a 1000)amount (i.e., the amount which must be repaid when the bonds mature). For example, a bond price of 96 indicates that a bond is selling at 96% of its face value (a discount), while a bond price of 103 indicates that the bond is selling at 103% of its face amount (a premium).

14. Which of the following is an obligation requiring a series of payments to a lender? A) Current liability B) Installment note c) Accounts payable D) Series note payable E) None of the above

b) installment payments Feedback: An installment note is an obligation requiring a series of payments to the lender. (Learning Objective P5)

registered bonds

bonds issued in the names and addresses of their holders/owners

bearer (coupon) bonds

bonds not registered in the name of the owner

callable bonds

bonds that a corporation reserves the right to redeem before their maturity

serial bonds

bonds that mature in installments at regular intervals

Bond price is found by

determining the present value of the cash flows for the face value and interest payments, discounted at the market rate of interest.

Corporate Bonds

like capital stock, are traded on national securities exchanges. Thus, bondholders have the opportunity to convert their holdings into cash at any time by selling the bonds at the current market price.

bonds

like common stock, are sold in small denominations (usually a thousand dollars), and as a result, they attract many investors.

Carrying value < Retirement Price =

loss

How are bonds classified

term bonds registered bonds callable bonds Bearer(coupon) bonds serial bonds debentures convertible corporate

In authorizing the bond issues

the board of directors must stipulate the number of bonds to be authorized, total face value, and contractual interest rate.

Term Bonds

they are called this When all bonds of an issue mature at the same time,