Acct Exam 3

Marwick Corporation issues 8%, 5-year bonds with a par value of $1,000,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 6%. What is the bonds issue (selling) price, assuming the following present value factors:

$1,085,308 Interest exp= $1,000,000 * 0.08% stated (contract) interest rate * 1/2 = $40,000 (this is an annuity) ($1,000,000 * 0.7441) + ($40,000 * 8.5302) = $1,085,308

Clabber Company has bonds outstanding with a par value of $100,000 and a carrying value of $97,300. If the company calls these bonds at a price of $95,000, the gain or loss on retirement is:

$2,300 gain

Advantages of bonds

1. Bonds do not affect owner control 2. Interest on bonds is tax deductible 3. Bonds can increase return on equity

Disadvantages of bonds

1. bonds can decrease return on equity 2. bonds require payment of both periodic interest and the par value at maturity

What accurately describes a debenture?

A type of bond which is not collateralized but backed only by the issuers general credit standing.

Adonis Corporation issued 10-year, 8% bonds with a par value of $200,000. Interest is paid semiannually. The market rate on the issue date was 7.5%. Adonis received $206,948 in cash proceeds. Which of the following statements is true?

Adonis must pay $200,000 at maturity plus 20 interest payments of $8,000 each

The effective interest amortization method:

Allocates bond interest expense over the bond's life using a constant interest rate.

straight-line method

Allocates equal bond interest expense to each interest period

Bond Retirement

Also called bond redemption, can retire bonds before maturity with two options; 1) exercise a call option 2)open market purchase

A company issued 8%, 15-year bonds with a par value of $550,000 that pay interest semiannually. The market rate on the date of issuance was 8%. The journal entry to record each semiannual interest payment is:

Debit Bond Interest Expense $22,000 ; Credit Cash $22,000

On July 1, Shady creek resort borrowed $250,000 cash by signing a 10-year, 8% installment note requiring equal payments each June 30 of $37,258. What is the appropriate journal entry to record the issuance of the note?

Debit Cash $250,000 ; Credit Notes Payable $250,000

If we want to know the value of present-day assets at a future date, we can use:

Future value computations

callable bonds

Gives the issuer the option to retire them at a stated dollar amount before maturity.

convertible bonds

Have the right to convert their bonds to stock, carrying value is transferred to equity accounts and no gain or loss is recorded.

Collateral agreements with secured bonds

If the issuer does not pay it's debt, the secured holders can demand that collateral be sold and the proceeds used to pay the obligation

Installment Notes

Liability requiring a series of payments to the lender

Serial bonds

Mature at more than one date (often in series) and thus far are usually repaid over over a number of periods

Premium on Bonds Payable

Occurs when the contract rate is higher than the market rate.

Sinking fund bonds

Reduce the holders risk by requiring the issuer to set aside assets to pay debt in a sinking fund

Present Value of a Bond

The issue price of bonds is the present value of the bonds' cash payments, discounted at the bonds' market rate.

The carrying value of a long term note payable is computed as:

The present value of all remaining payments, discounted using the market rate of interest at the time of issuance.

A bond holder that owns a $1,000, 10%, 10-year bond has:

The right to receive $1,000 at maturity.

Bonds issued at par

The stated interest rate is equal to the market interest rate

Bonds issued at discount

The stated interest rate is less than the market interest rate.

Debt to Equity Ratio

a measure to assess the risk of a company's financing structure. total liabilities/total equity

effective interest method

allocates total bond interest expense over the bonds' life in a way that yields a constant rate of interest.

Amortizing a bond discount:

bond discount / number of interest periods = bond discount amortization. Issue price is less than par value. uses the straight-line method.

Registered bonds

bonds issued in the names and addresses of their holders

Amortizing a Bond Premium

bonds sell at a price higher than par value

Secured bonds

have specific assets of the issuer pledged as collateral

Discounts on bond payable

occurs when a company issues bonds with a contract rate less than the market rate.

Interest Calculation

principal x rate x time

Bonds issued at a premium

the stated interest rate is more than the market interest rate