ACCT Chapter 12 Review Questions

12. What type of account is Discount on Bonds Payable? What is its normal balance? Is it added to or subtracted from the Bonds Payable account to determine the carrying amount?

Bond A bond is a debt instrument which is issued by companies to raise capital. The holder of this instrument are called bond holders, who are entitled to receive a fixed amount of interest on the face value of the bond. A bond is said to be issued at discount when the issue price of a bond is less than the face value of such bond. Discount on bonds payable is a contra liability account, because it is contrary to the normal credit balance. Its normal balance is Debit balance. Discount on bonds payable account is added to determine the carrying amount.

6.When does a discount on bonds payable occur?

Bonds issued at a discount Bond is explained as follows: Bond is a long-term financial instrument issued by a company for which the company pays interest to the bond holders. A bond issue is the total value of bond issued at a time. Bond prices are declared in terms of a percentage of the face value/principal of bonds. Bonds issued at a discount are explained as follows: Bonds will be issued at a discount when the issue price of the bond will be less than the face value. Here, the stated rate of interest will be less than the market interest rate.

15. What does it mean when a company calls a bond?

Callable Bonds The Callable bonds are explained as below: An interest-bearing security or long-term promissory note that a company represents while borrowing money from outsiders is called bond. The company calls back bonds when it wants to settle them before maturity. The bond is paid back at a specific price . Therefore, these bonds are called callable bonds.

17. What does the debt to equity ratio show, and how is it calculated?

Debt to Equity Ratio Debt to equity ratio provides the long-term financial soundness of the company. It shows the relationship between total liabilities and total equity. If debt to equity ratio is low, then the company has a less financial risk. If it is high, then the ratio is unfavorable and company is at a higher risk. It is calculated as given below: Debts to equity ratio = Total Liabilities Total Equity

2.What is an amortization schedule?

The schedule that shows what part of the monthly payment is paid on the principal and what part of the monthly payment is paid in interest is called an amortization schedule.

9.Why would a company choose to issue bonds instead of issuing stock?

Although issuing bonds carries a risk, companies want to issue debt instead of stock issue. The reason is debt issue costs less to company instead of stock issue. Moreover, debt issue does not affect the percentage of the ownership of the corporation. Net income may be higher for the company which issue common stock but the company which issues bonds will have more earnings per share. Company may not be able to pay interest amount of the bonds- risk to the company. Even though company issues debt rather stock issue due to the above mentioned two reasons. Company can save money by issuing bonds payable rather stock issue.

1. Where is the current portion of notes payable reported on the balance sheet?

At the end of each period every company reports current liabilities and long-term liabilities in the balance sheet. The current portion of the notes payable reported in the current liabilities section on the liabilities side of the balance sheet . Therefore , the current portion of notes payable reported in the balance sheet as follows. X company Balance sheet (partial) Liabilities Amount $ Current Liabilities Current portion of the notes payable $000

13. What type of account is Premium on Bonds Payable? What is its normal balance? Is it added to or subtracted from the Bonds Payable account to determine the carrying amount?

Bond A bond is a debt instrument which is issued by companies to raise capital.The holder of this instrument are called bond holders, who are entitled to receive a fixed amount of interest on the face value of the bond. A bond is said to be issued at premium when the issue price of a bond is more than the face value of such bond . Adjunct account: Adjunct account are the account which are directly related to other accounts. Premium on bonds payable is an adjunct account. For example, a company issues $300,000 of bonds at a price of $102; it will be issuing the bonds at premium of 2%. In its books company will debit the cash by $36,000, credit the bonds payable by $300,000 and credit the premium on bonds payable by $6,000. Premium on bonds payable account will be amortized over the period of interest payments. Its normal balance is credit balance. Premium on bonds payable account is deducted to determine the carrying amount.

11.In regard to a bond discount or premium, what is the straight-line amortization method?

Bond Discount When the selling price of a bond is lower than its face value, the bond is said to be issued at a discount. Example: Company A issued $500,000, five-year bonds at 95. In the example, the price of the bond is 95, which is 5 less than the face value (100). So, we can say that the bond is issued at a discount. Bond Premium When the selling price of a bond is higher than its face value, the bond is said to be issued at a premium. Example: Company A issued $500,000, five-year bonds at 105. In the example, the price of the bond is 105, which is 5 less than the face value (100). So, we can say that the bond is issued at a premium. Amortization is the process of dividing, spreading and reducing the cost of the bond over the life of the bond. In the straight-line amortization method, the amount of bond discount or bond premium is amortized equally for each interest period over the life of the bond.

8. When a bond is issued, what is its present value?

Bonds An interest bearing security or long-term promissory note that a company represents while borrowing money from outsiders is called as bond. When a bond is issued, the present value of the bond is its market price. The price of issued bond is equal to the present value of principal amount plus the present value of stated interest amount.

14. What is the journal entry to retire bonds at maturity?

Bonds An interest-bearing security or long-term promissory note that a company represents while borrowing money from outsiders is called bond. The following is the journal entry to record the retirement of the bond at maturity: Accounting equation: The following is the accounting equation for the entry: Assets = Liabilities + Equity -$XXX(Cash)= -$XXX(Bonds Payable) Journal entry: Record the following journal entry in the books of the company: Date Accounts and Explanation Post Ref Debit ($) Credit ($) Bonds Payable (L-) XXX Cash (A-) XXX (To record the retirement of bonds payable at maturity.) Explanation: Bonds payable is a liability and it decreases by $XXX. Therefore, debit bonds payable account by $XXX. Cash is an asset and it decreases by $XXX. Therefore, credit cash account by $XXX.

10.What is the carrying amount of a bond?

Carrying amount of the bond Bond: Bond is a long-term financial instrument issued by a company for which the company pays interest to the bond holders. Bonds issued at a discount: If the bonds are issued at a price which is less than the face value, they are referred to as bonds issued at a discount. Bonds issued at a premium: If the bonds are issued at a price more than the face value, than they are referred to as bond issued at a premium. Carrying amount of the bonds issued at a discount: The carrying amount is the difference between the bonds payable amount and the current discount account balance. Carrying amount of the bonds issued at a discount: The carrying amount is the sum of the bonds payable amount and the current premium account balance.

20A. How does compound interest differ from simple interest?

Differentiation between compound interest and simple interest: The interest which is calculated only on principal amount is simple interest. In the concept of compound interest, compound interest is calculated on the sum of principal amount and interest amount of all the previous years. The underlying assumption in the compound interest is interest amount is re-invested to earn more interest. For example say simple interest, if $1,000 invested to earn 6% interest per year for 5 years. The interest amount would be &60 (i.e., &1,000 * 0.06) per year and total interest would be &300 (i.e.,5*$60) for 5 years. If it is compound interest where all the figures are same just like simple interest, first year interest amount would be $60 (i.e.,$1,000*0.06) and second year interest would be $63.6 (i.e.,($1,000+$60)*0.06) and so on for the remaining periods.

21B. In regard to a bond discount or premium, what is the effective-interest amortization method?

Effective-interest amortization method As per effective method of amortization, the amount of discount or premium is allocated as follows : As per generally accepted accounting principles (GAAP), interest expenses for bond is calculated by effective-interest method of amortization. Effective-interest method of amortization is amortization model that apportions the amount of bond discount or premium based on the market interest rate at the time of issue. Accounting for a long-term note payable On January 1, 2018, Lakeman-Fay signed a $1,500,000, 15-year, 7% note. The loan required Lakeman-Fay to make annual payments on December 31 of $100,000 principal plus interest. Requirements Journalize the issuance of the note on January 1, 2018. Journalize the first note payment on December 31, 2018. Note-Payable with interest Notes payable is the amount borrowed by the company from the bank and repaid after a certain period of time with payment of interest. Repayment of principal amount may be at the end of the period or a yearly payment depending upon the terms. Company records the transaction at the end of the each period. Given, Company signed a 15 year, 7% note payable on january 1, 2018, of $1,500,000. The note requires annual principal payments each December 31 of $100,000 plus 7% interest. Prepare the following journal to record the issuance of note: Date Accounts DR. (S) CR. (S) Jan,1 Cash 1,500,000 Notes payable 1,500,000 (Received cash in exchange of note) Cash is received in exchange of notes payable, so cash account is debited and notes payable liabilities is raised. Prepare the following journal to record the payment on December, 31,2018 Date Accounts DR.(S) CR.(S) Dec,31 Notes payable 100,000 Interest expenses 105,000 Cash 205,000 (To pay the interest and annual installment) Payment of interest and first installment of $100,000 is made, so notes payable is reversed by $100,000 and interest expense is booked and cash is credited with the cumulative amount. Compute the amount of repayment as on December, 31,2018 as follows: Repayment Amount = Principal payment + Interest payment\ = $100,000+($1,500,000*7%) = $100,000+$105,000 = $205,000 Accounting for mortgages payable Ember Company purchased a building with a market value of $280,000 and land with a market value of $55,000 on January 1, 2018. Ember Company paid $15,000 cash and signed a 25-year, 12% mortgage payable for the balance. Requirements Journalize the January 1, 2018, purchase. Journalize the first monthly payment of $3,370 on January 31, 2018. (Round to the nearest dollar.) Mortgages payable: Mortgages payable are the long-term liabilities secured with specific assets. If the mortgage is not paid on schedule time, secured asset will be transferred to the bank, If the mortgage is to be paid within 1 year then it will be considered as current liability and in other case it will be long-term. Given, Ember Company purchased a building with a market value of $280,000 and Land with a market value of $55,000 on January 1, 2018. Ember Company paid $15000 cash and signed a 25-year 12% mortgage payable for the balance. Prepare the following journal to record the purchase on January 1 2018. Date Accounts DR.(S) CR.(S) Jan,1 Building 28000 Land 55000 Mortgages payable 320000 Cash 15000 (Purchased building and land with a mortgage payable) Land and building are purchased with a cash payment of $15000 and with a mortgage payable for the balance amount , so Building and land is debited, cash is credited and mortgages payable liabilities is raised. Prepare the following journal to record the first monthly payment of $3,370 on January,31,2018 Date Accounts DR.(S) CR.(S) Jan,31 Mortgages payable 170 Interest expense($320000*12%*1month) 3200 Cash 3370 (To pay the interest and annual installment) Payment is made for the first month which is inclusive of interest, interest expense is calculated and booked, cash is credited and mortgage liability is reversed for the balance amount.

16. What are the two categories of liabilities reported on the balance sheet? Provide examples of each

Liabilities Liabilities is an agreement made by a company to pay a specified amount for the goods or services received by the company in the past. The following are the two categories of liabilities reported in the balance sheet: Current Liabilities Long-term Liabilities Current Liabilities: The liabilities which are required to be paid within 1 year are referred to as current liabilities. Examples of Current Liabilities : Examples of current liabilities are given below: Accounts Payable Salaries Payable Interest Payable Sales Tax Payable Current portion of Notes Payable Current portion of Mortgage Payable Current portion of Bonds Payable Long-term Liabilities: The Liabilities which have a longer maturity period (more than 1 year) are referred to as long-term liabilities. Examples of Long-term Liabilities: Examples of long-term liabilities are given below: Notes Payable Mortgage Payable Bonds Payable

4.What is a bond payable?

Many companies in the world need large money for their long -term operations. For their needs companies may term loan from banks or from financial institutions or raise money by issuing bonds payable to general public.Those who purchased bonds from companies are called bondholders. For example, company can issue $100 bonds to one lender (say) 1,000 bonds to raise $100,000 for long-term needs.

3.What is a mortgage payable?

Mortgage Payable Mortgage payable is explained as follows: Mortgage payable is a long -term debt, which is secured by fixed assets. The company has to pay the mortgage with interest. A portion of the amount is to be paid within a year another portion will be due more than one year.

7.When does a premium on bonds payable occur?

Premium on bonds pay Bonds payable: Bonds payable is long-term legal agreement issued by a company to several Bondholders. Bondholders are entitled to receive a specified interest on the bonds bought by them. Premium on bonds payable If the bonds are issued at a price more than the face value, then Premium on Bonds Payable occurs. Example: Company A issued $ 400,000, five-year bonds at 108. In the example, the price of the bonds is 108, which is more than the face value(100). The premium (8) would be the difference between the issue price (108) and face value (100).

5.What is the difference between the stated interest rate and the market interest rate?

The stated interest rate is described as amount of cash what borrower pays and investor receives each period. This Stated interest rate is also called as face rate, coupon rate or nominal rate. Market interest rate is also known as effective interest rate. It is what investor demands in order to loan their money or market by investing. When market rate of interest is more than the stated rate bond can sell only at discount. Market rate of interest is more than the stated rate of interest many times. Investors invest in bonds only after they determine that investing at stated interest rate with discount is better than investing at market rates.

18A. Explain each of the key factors that the time value of money depends on.

Time value of money. Any money invested earns an additional percentage of income after a certain period. This is called as time value of money. This depends on the following key factors: The principal amount is the amount of investment made. This is denoted as p. The number of periods is the duration. It starts from time of investment until the investment gets terminated. It is denoted by (n). The interest rate is the additional amount earned on the investment and calculated in percentage. It is denoted by (i). The interest rates are stated annually in days, months, or quarters.