ACCT 206 Quiz Chapter 10 TEST 3

SB On January 1, Year 1, Mahoney Company... [The following information applies to the questions displayed below.] On January 1, Year 1, Mahoney Company borrowed $172,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $40,825. What is the amount of principal repayment included in the payment made on December 31, Year 1?

$27,065 (Year 1 Interest expense = Principal balance on January 1 of $172,000 × 8% = $13,760 Year 1 Principal repayment = Payment of $40,825 − Interest portion of $13,760 = $27,065)

Kier Company issued $560,000 in bonds on January 1, Year 1. The bonds were issued at face value and carried a 3-year term to maturity. The bonds have a 5.50% stated rate of interest and interest is payable in cash on December 31 each year. Based on this information alone, what are the amounts of interest expense and cash flows from operating activities, respectively, that will be reported in the financial statements for the year ending December 31, Year 1?

$30,800 and $30,800 (Since the bonds were issued at face value, the cash payment for interest equals the interest expense. Payment of interest = Face value of $560,000 × .055 = $30,800 The payment of interest on December 31, Year 1, increases interest expense by $30,800 and is reported as a cash outflow for operating activities.)

Which of the following correctly describes an installment note?

An installment note requires equal payments of interest and principal in which the amount of interest decreases over the life of the note. (Loans that require payments of principal and interest at regular intervals (amortizing loans) are typically represented by installment notes. As the principal balance of the note decreases over time the portion of the payment that is applied to interest expense decreases. However, the amount of the payment remains constant.)

On January 1, Year 1, Burton Corporation recorded the following journal entry: Cash (Debit) 196,000 Discount on Bonds Payable (Debit) 4,000 Bonds Payable (Credit) 200,000 Which of the following correctly describes the related transaction?

Burton issued bonds at 98. (Proceeds of $196,000 = Face value of $200,000 × Issue price Issue price = $196,000 ÷ $200,000 = 98 A $200,000 bond issued at 98 will be recorded as a debit (increase) to cash for $196,000, the issue price, a debit (increase) to discount on bonds payable (a contra liability) for $4,000, and a credit (increase) to bonds payable for $200,000, the bond's face value.)

Chico Company borrowed $40,000 on a four-year, 8% installment note. How will Chico record the issuance of this note?

Cash 40,000 Notes Payable 40,000 (Issuing a long-term installment note is recorded by debiting (increasing) cash and crediting (increasing) the liability notes payable for the face value of the note.)

Clayton Corporation made the following entry in its general journal: Interest expense (Debit) 5,400 Discount on bonds payable (Credit) 400 Cash (Credit) 5,000 Which of the following describes the above transaction?

Clayton records interest expense and amortization of discount on bonds payable. (The payment of cash and recognition of interest expense (which, in this case, includes the amortization of the discount on bonds payable) decreases assets (by crediting cash), increases liabilities (by crediting discount on bonds payable, a contra-liability account), and increases expenses (by debiting interest expense).)

What is another term used to describe unsecured bonds?

Debentures (Unsecured bonds, also called debentures, are issued based on the general strength of the borrower's credit.)

Which of the following statements is true regarding the straight-line method of amortizing discounts and premiums on bonds?

It assigns the same amount of interest to each interest period over the life of the bond. (The straight-line method amortizes the discount equally over the life of the bond. While the straight-line method is easy to understand, it is inaccurate because it does not show the correct amount of interest expense incurred during each accounting period. This straight-line recognition pattern is irrational because the amount of interest expense recognized should increase as the carrying value of the bond liability increases. A more accurate recognition pattern can be accomplished by using an approach called the effective interest rate method.)

What is the name used for the type of secured bond that requires a pledge of a designated piece of property in case of default?

Mortgage bond (Secured bonds grant their holders a priority legal claim on specified identifiable assets should the issuer default. A common type of secured bond is a mortgage bond, which conditionally transfers the title of designated property to the bondholder until the bond is paid.)

How does the amortization of the principal balance on an installment note payable affect the amount of interest expense recorded each succeeding year?

Reduces the amount of interest expense each year (As the principal balance declines each year, the interest expense becomes smaller, and the amount of principal repayment becomes larger with each subsequent payment.)

Which of the following is one of the main advantages of using long-term debt financing instead of equity financing?

Tax-deductibility of interest (One of the main advantages of debt financing is that interest paid on bonds and notes is tax-deductible, while dividends paid on equity financing is not.)

Which of the following describes what happens when bonds are issued when the market interest rate is less than the stated interest rate?

The bonds are issued at a premium. (When the market rate of interest is lower than the stated rate of interest, bonds will sell at a premium so as to reduce the effective rate to the market rate. On the other hand, when the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate.)

A discount or premium on bonds payable can be defined by which of the following statements?

The difference between the market price on the issue date and the face value. (When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. When the market rate is lower than the stated rate, bonds will sell at a premium so as to reduce the effective rate to the market rate.)

On January 1, Year 1, Strang Incorporated issued bonds with a face value of $500,000, a stated rate of interest of 8%, and a 5-year term to maturity. The effective rate of interest was 10%. Interest is payable in cash on June 30 and December 31 of each year. Which of the following statements is true?

This bond was issued at a discount, and each semiannual cash payment is $20,000. (When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. Semi-annual interest payment = Face value of $500,000 × 8% × ½ = $20,000)

(T/F) On January 1, Year 1, Daniels Company issued bonds with a face value of $500,000, receiving $496,000 cash. When the bonds mature, Daniels will have to pay the face value of the bonds to the bondholders.

True (The face value is the amount paid to bondholders at maturity, whether the bonds were issued at a premium, a discount, or face value.)