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122 Cards in this Set
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Definitions - Bond Indenture |
The document that describes the contract between the issuer (borrower) and bond-holders (lenders) |
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Definitions - Face (Par) Value |
Face value is the total dollar amount of the bond and the basis on which periodic interest is paid. Bonds are issued at face (par) value when the sated rate equals the market. |
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Definitions - Stated (Nominal or Coupon) Interest Rate |
The stated interest rate, also known as the nominal interest rate or the coupon rate, is the interest to be paid to the investors. This rate is specified in the bond contract. |
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Definitions - Market (Effective) Interest Rate |
The market interest rate is the rate of interest actually earned by the bondholder and is the rate of return for comparable contracts on the date the bonds are issued. |
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Definitions - Discount |
If the market rate is higher than the stated rate, the bonds will be issued at a premium because the investor will pay more than face value due to the higher return offered. |
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Types of Bonds: |
1. Debentures: unsecured bonds 2. Mortgage bonds: bonds secured by real property. 3. Collateral Trust Bonds: secured by bonds 4. Convertible bonds: convertible into common stock at the option of bondholder. 5. Participating Bonds: have a stated rate of interest & participate in income if certain earnings levels are obtained. |
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Types of Bonds (continued): |
6. Term bonds: have single fixed maturity date. Entire principal paid @ end of term. 7. Serial bonds: pre-numbered bonds that issuer may call & redeem a portion by serial #. 8. Income bonds: bonds that only pay interest if certain income objectives are met. 9. Zero coupon bonds: AKA "deep discount bonds" sold w/ no stated interest but at a discount & redeemed @ face value w/o periodic interest payments. 10. Commodity-backed Bonds: AKA "asset-linked bonds" redeemable in cash or a stated volume of a commodity, whichever is greater. |
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Overview of Recording Bonds: |
Bonds payable should be recorded as a long-term liability at face value at face value and adjusted to PV of their future cash outflows by either subtracting unamortized discounts or adding unamortized premiums. Bonds payable are recorded at the true PV at the date of issuance based on the market (effective) interest rate at that date. |
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Overview of Bond Terms: |
A. Usually in denominations of $1,000. B. Price is quoted in 100's (% of par value). C. Indenture =a contract for purchase of bond. D. Coupon rate = the stated interest rate on the bond. E. Bond interest (check amount) = coupon rate x face. F. Principal payoff always the full face amount. G. Premium/discount is result of buyer & seller "adjusting" coupon rate to prevailing market rate of interest. |
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Accounting for the issuance of bonds - Bond selling price |
When a bond is issued, the price is computed as the sum of the PV of the future principal payment + PV of future periodic interest payments. Both cash flows are discounted at the prevailing market rate of interest. This recorded price is the value of the bond at its current cash equivalent. |
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Accounting for the issuance of bonds - Bond selling price - Bonds Issued @ Par Value |
A bond is issued @ par value when the stated rate on the bond = the market (effective) interest rate on the date the bonds are issued. |
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Accounting for the issuance of bonds - Bond selling price - Bonds Issued @ a Discount |
A bond is issued at a discount when the stated rate on the bond is less than the market (effective) interest rate on the date the bonds are issued. |
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Accounting for the issuance of bonds - Bond selling price - Bonds Issued @ a Premium |
A bond is issued at a premium when the stated rate on the bond is greater than the market (effective) interest rate on the date the bonds are issued. |
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Accounting for the issuance of bonds - Stated Interest Rate |
Stated interest rate is typically printed on the bond & included in bond indenture before the bond is brought to market. Stated rate won't change, regardless of market rate @ issuance date. The cash received by a bondholder at regular interest payment intervals throughout the life of the bonds will always be at the stated rate applied to the face amount of the bond. |
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Accounting for the issuance of bonds - Effective Interest Rate |
Because the cash to be received in future is fixed @ time bond is sold, market automatically adjusts issue price of bond so purchaser receives the market rate of interest for comparable risk bonds. A discount or premium on the bonds will exist when bonds are issued w/ stated rate that differs from market rate at issuance date. |
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Accounting for the issuance of bonds - Discounts |
If market interest rate is higher than stated interest rate, bonds sell at discount. This means the bond will sell for less than face value of bond (<100% of par). The difference between face value of the bond & the sales price of the bond is the automatic adjustment to the interest rate. |
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Accounting for the issuance of bonds - Discounts - Unamortized Discount |
The unamortized discount is a contra account to bonds payable, which means that it is presented on the balance sheet as a direct reduction from the face (par) value of the bonds to arrive at the bond's carrying value at any particular point in time. |
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Accounting for the issuance of bonds - Discounts - Amortization of the Discount - General |
Bond discount represents additional interest to be paid to investors at the bond maturity & is amortized over life of bond. The discount is amortized over the life of the bond, w/ amortized amounts increasing interest expense each period. Therefore, the amortization of the discount is added to the amount of cash paid @ stated rate to obtain GAAP interest expense. |
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Accounting for the issuance of bonds - Premium |
If market interest rate < stated interest rate, the bonds sell at premium. The difference between the face value of the bond & the sales price of the bond (i.e., the premium) is the automatic adjustment to the interest rate.
Bonds Payable Less: Unamortized discount |
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Accounting for the issuance of bonds - Premiums - Unamortized Premium |
The unamortized premium on bonds payable is presented on the balance sheet as a direct addition to the face (par) value of the bonds to arrive at the bond's carrying value at any particular point in time.
Bonds payable Add: Unamortized premium |
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Accounting for the issuance of bonds - Premiums - Amortization of the Premium - General |
Bond premium represents interest paid in advance to issuer by bondholders who receive a return of premium in the form of larger periodic interest payments (@ stated rate). The bond premium is amortized over the life of the bond, w/ amortized amounts decreasing interest expense each period. Amortization of premium is subtracted from cash paid @ stated rate to obtain GAAP interest expense. |
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Accounting for the issuance of bonds - Carrying Value |
As bonds approach maturity, their carrying values approach face value , so the carrying value of the bonds equals face value @ maturity. Carrying value of a bond equals face plus the balance of unamortized premium or face minus the balance of unamortized discount. Carrying value of a bond w/ discount increases to maturity value as the discount is amortized. The carrying value of a bond w/ a premium decreases to maturity value as the premium is amortized. |
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Bond Issue Costs |
Transaction costs of the bond issue. E.g., legal fees, accounting fees, underwriting commissions, and printing. These should be recorded as deferred charge (an asset) & amortized from issuance date into expense. Bond issue costs are typically paid directly by broker & repaid to broker by company through proceeds of the bond issue. Which means the issuing company receives bond porceeds net of bond issue costs. |
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U.S. GAAP vs. IFRS: Bond Issue Costs |
Under IFRS, bond issue costs are not recorded as a separate asset. Bond issue costs are deducted from the carrying value of the liability and amortized using the effective interest method. |
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Methods of Discount & Premium Amortization - Amortization Period |
Under U.S. GAAP, the period over which to amortize a bond premium or discount is the time period that the bonds are outstanding (i.e., from the date the bonds are sold). In general, U.S. GAAP amortization is done over the contractual life of the bond. |
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U.S. GAAP vs. IFRS: Amortization Period for Discounts & Premiums |
Under IFRS, amortization is done over the expected life of the bond, not the contractual life of the bond. |
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Methods of Discount & Premium Amortization - Straight-Line Method |
This method of amortization results in a constant dollar amount of interest each period. The SL method is NOT GAAP but is allowed under U.S. GAAP if the results are not materially different from the effective interest method. |
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Methods of Discount & Premium Amortization - Straight-Line Method - How to calculate interest expense: |
Interest expense is calculated as follows:
Premium or discount/# of periods bond is outstanding = Periodic amortization
Interest expense = (Face value x Stated interest rate) - Premium amortization or plus discount amortization |
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U.S. GAAP vs. IFRS: Straigth-Line Method of bond amortization |
The straight-line method is not permitted under IFRS. |
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Methods of Discount & Premium Amortization: Effective Interest Method |
Effective interest method for amortization of unamortized discounts/premiums is required by GAAP AND IFRS. This method of amortization results in a constant rate of interest each period. The difference between interest expense & cash paid for interest each period. Difference between interest expense & cash paid for interest is amortization for period of discount or premium. |
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Methods of Discount & Premium Amortization: Effective Interest Method - Calculate Interest Expense |
Interest Expense:
Interest expense = Carrying value @ beginning of period x Effective interest rate |
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Methods of Discount & Premium Amortization: Effective Interest Method - Discount/Premium Amortization |
Amortization of the discount = Interest expense - Cash interst paid @ stated rate
Amortization of the premium = Cash interest paid @ stated rate - Interest Expense |
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Journal entries for issuing bonds at premium and discount: |
Premium Dr: Cash Cr: Premium on bonds payable Cr: Bonds payable
Discount Dr: Cash Dr: Discounts on bonds payable Cr: Bonds Payable |
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Bonds issued between interest dates |
Bonds are usually sold between interest dates, which requires additional entries for accrued interest at the time of sale. The amount of interest that has accrued since the last interest payment is added to the price of the bond. The purchaser pays such interest & is reimbursed at the next payment date upon receipt of a full period's interest. |
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Year-end Bond Interest Accrual: |
When the date of a scheduled interest payment & the issuer's year-end do not agree, it is necessary to accrue interest by an adjusting entry on the issuer's books at year-end. The accrual must into account a pro-rated share of discount or premium amortization. |
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Bond sinking funds: |
A bond sinking fund is a trustee fund (restricted cash) pursuant to the indenture wherein the company contributes money each year so that at maturity, there is a sum available to repay the entire liability. |
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Bond sinking funds: Classification |
The sinking fund is generally a non-current (restricted) asset on the financial statements of the issuer. It is a current asset only to the extent that it offsets a current liability. |
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Bond sinking funds: Sinking Fund Balance |
The sinking fund earns interest or dividends over time. The accumulated deposits & interest/dividends thereon will be used to pay the bonds upon maturity. The amount accumulated from regular deposits with the trustee serve as collateral for the issued bonds. |
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Bond sinking funds: Appropriation |
A bond sinking fund reserve is merely an appropriation of retained earnings to indicate to the shareholders that certain retained earnings are being accumulated for bond sinking fund purposes. |
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Bond sinking funds: Footnote |
The amount of current maturities of long-term debts does not include the annual sinking fund requirement (which is outlined in the bond indenture), but the amount would be included as a footnote. |
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Determination of the Periodic Sinking Fund Payments |
To determine the periodic payments to be made into the fund, the future value of an annuity of $1 at an assumed rate must be used because the periodic deposits are earning interest. |
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Serial Bonds: Mature in Installments |
Serial bonds have principals that mature in installments. These bonds allow the issuer to match maturity dates with the organization's cash flow requirements.
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Serial Bonds: Accounting for Serial Bonds |
PV of each maturity in should be separately calculated, as in the case of a term bond: 1. Since short & long term interest rates often differ, there also could be a different discount or premium relating to each maturity. 2. One account, Unamortized Bond Discount or Unamortized Bond Premium, is used to accumulate all the discounts or premiums for each maturity. 3. PV of the periodic interest payments for each maturity is calculated separately, based on these different yield rates, just like term bonds. 4. When underwriters bid on an entire serial bond issue at one avg. interest rate, an avg. yield can be used for all maturities to calculate interest expense. |
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Serial Bonds: Amortization on serial bonds |
Amortization on serial bonds are: a. Effective Interest Method (just as explained for term bonds) b. Bonds Outstanding Method: The variation of the SL method uses the % of decrease in outstanding debt each maturity period as the basis for calculating the related amount of premium or discount on the bonds. The bonds outstanding method is not GAAP, but has been tested on the CPA exam. |
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Convertible bonds: Overview |
Convertible bonds are often issued at more than face value because of the value of the conversion feature. Under U.S. GAAP, the issuance price is allocated to the bonds with no recognition of the conversion feature because it is difficult to assign a specific value the conversion feature. |
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U.S. GAAP vs. IFRS: Convertible Bonds |
Under IFRS, both a liability (bond) and an equity component (conversion feature) should be recognized when convertible bonds are issued. The bond liability should be valued at FV, with the difference between the actual proceeds received & the FV of the bond liability recorded as a component of equity. This is similar to the accounting for bonds with detachable warrants. |
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Convertible Bonds - Book Value Method |
Under BV method, no gain or loss recognized. At conversion, bond payable & related premium or discount are written off & common stock is credited (at par). Add'l paid in capital is credited for excess of bond's carrying value over stock's par value less any conversion costs. No gain or loss is recognized cuz BV method views the conversion as the completion of a prior transaction (issuance of convertible debt), rather than viewing it as culmination of the earning process. |
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Convertible Bonds - Book Value Method - Upon Conversion, the issuer must: |
1. Pay the accrued interest up to the conversion date. 2. Amortize the bond discount or premium up to the conversion date. 3. Amortize the bond issue costs up to the conversion date, and 4. Record any difference as additional paid-in capital. |
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Convertible Bonds - Market Value Method: |
Market value method views the conversion as culmination of the earnings process, resulting in recognized gain or loss. At conversion, the bonds payable & related premium are written off, & common stock is credited (at par). Credit to additional paid-in capital is the excess of the market price of the stock over par value. The difference between market value of stock & BV of bonds is a recognized gain or loss on redemption. |
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Convertible Bonds - Premium: |
Since conversion feature cannot be assigned a value, the difference between the proceeds & the face value of the bonds is recorded as a premium on bonds payable. When the conversion feature is exercised, any unamortized premium attributable to that portion of the converted bonds must be written off. |
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Bonds Sold With Detachable Stock Purchase Warrants - Overview |
Warrants are option contracts issued w/, & detachable from, bonds (& notes). Warrant gives bondholder right to buy stock @ fixed price w/i specific time period. Because they are detachable, warrants are traded separately and are considered a separate financial instrument. Thus they are accounted for differently than convertible bonds under GAAP. |
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Bonds Sold With Detachable Stock Purchase Warrants - Account for Separately |
A conversion feature separate from a security is accounted for separately, & a value is assigned to it. The value assigned is its relative FV @ time of issue. This amount is credited to A.P.I.C.--warrants. A value is assigned to a conversion feature only if it is detachable and has its own market value. |
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Bonds Sold With Detachable Stock Purchase Warrants - Account for Separately - Journal Entry |
Dr: Cash Cr: Bonds payable Cr: A.P.I.C. -- warrants |
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Bonds Sold With Detachable Stock Purchase Warrants - Accounting Treatment |
Bonds w/ detachable stock purchase warrants may be recorded at issuance using two different methods. The warrants only method is used if only the FV of the warrants is known. The market value method (warrants and bonds method) is used if the FV of both the warrants & bonds are known. |
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Bonds Sold With Detachable Stock Purchase Warrants - Accounting Treatment - Journal Entry for Exercise of Warrants |
On the exercise date, the following journal entry is used to record the issuance of stock to the holder of the warrant: Dr: Cash Dr: A.P.I.C. -- warrants Cr: Common stock (at par) Cr: A.P.I.C.
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Definition of Extinguishment |
A liability cannot be derecognized in the financial statements until it has been extinguished. A liability is considered extinguished if either of the following conditions are met: 1. Debtor Pays 2. Debtor Legally Released |
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In-substance Defeasance not Extinguishment |
An in-substance defeasance is an arrangement where a company places purchased securities into an irrevocable trust and pledges them for the future principal & interest payments on its long-term debt. Because the company remains the primary obligor while there is outstanding debt, the liability is not considered extinguished by an in-substance defeasance. |
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Gain or Loss on Bond Extinguishment before Maturity - Adjustment Items in the Financial Statements |
In any bond reacquisition, the following items must be accounted for & adjusted in the FSs: 1. Bond issue costs reported as an asset under GAAP. 2. Any related unamortized discount or premium 3. The difference between the bond's face value & the reacquisition proceeds. |
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Gain or Loss on Bond Extinguishment before Maturity - Calculation of the Gain or Loss |
Gain or loss on extinguishment of debt:
(Gain) or loss = Reacqusition price - Net carrying amount |
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Gain or Loss on Bond Extinguishment before Maturity - Calculation of the Gain or Loss - Reacquisition Price |
Reacquisition price is usually shown as a % of the bond's face value (e.g., $100,000 @ 102 or $100,000 @ 95). To calculate the reacquisition price, multiply the % by the face value (e.g., $100,000 x 102% = $102,000). |
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Gain or Loss on Bond Extinguishment before Maturity - Calculation of the Gain or Loss - net Carrying Amount |
The net carrying amount of the bond is the carrying value (i.e., face value of the bond plus unamortized premium or minus unamortized discount) minus unamortized bond issue costs reported as an asset (U.S. GAAP only). |
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Possible Extraordinary Item Treatment (U.S. GAAP) |
Under GAAP, the gain or loss on bond extinguishments (including bond refunding) by the company will be treated as a extraordinary item, net of the related tax effect if it is material in aggregate, unusual in nature, and has occurred infrequently. Gains and losses are not classified as extraordinary under IFRS. |
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The market price of a bond issued at a premium = the PV of its principal amount: a. And the PV of all future interest payments, at the market (effective) interest rate. b. And the present value of all future interest payments, at the stated interest rate. c. Only, at the market (effective) interest rate. d. Only, at the stated interest rate. |
Choice "a" is correct. To determine the market price of a bond, the present value of the principal is added to the present value of all interest payments, using the market interest rate. |
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July 1, Yr 1, Eagle issued 600 of its 10%, $1,000 bonds @ 99 + accrued interest. Bonds are dated April 1, Yr 1 & mature April 1, Yr 11. Interest is payable semi-annually April 1 & Oct 1. What did Eagle receive from bond issuance? a. $594,000 b. $579,000 c. $609,000 d. $600,000
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$609,000. 600 x $1,000 = $ 600,000 $600,000 x 99% = $ 594,000 $ 600,000× 10% = 60,000 x 3/12 = 15,000 Total cash proceeds: 594,000+15,000 = $ 609,000 |
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Jan 2, Year 1, West Co. issued 9% bonds in the amount of $500,000, which mature on January 2, Year 11. The bonds were issued for $469,500 to yield 10%. Interest is payable annually on December 31. West uses the effective interest method of amortizing bond discount. In its June 30, Year 1 balance sheet, what amount should West report as bonds payable? |
$469,500 x 10% = 46,950 $500,000 x 9% = 45,000 $46,950-$45,000 = $1,950 x 1/2 yr = $975 Bonds Payable = 46,950 + 975 = 470,475 |
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July 31, Yr 1, Dome issued $1,000,000 of 10%, 15-yr bonds @ par & used a portion of the proceeds to call its 600 outstanding 11%, $1,000 face value bonds, due July 31, Yr 11, at 102. On that date, unamortized bond premium relating to the 11% bonds was $65,000. In its Year 1 I/S, what amount should Dome report as gain or loss from retirement of bonds? |
Choice "d" is correct. A gain of $53,000 is recognized because the $665,000 book value of the debt ($600,000 face value plus $65,000 unamortized premium) is settled for $612,000 ($600,000 at 102). There is no accrued interest because the redemption takes place on an interest date. The proceeds from the new bond issuance are not relevant |
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Jan 1, Yr 2, Oak issued 400 of its 8%, $1,000 bonds at 97 + accrued interest. The bonds are dated October 1, Year 1, & mature Oct 1, Yr 11. Interest is payable semiannually April 1 & Oct 1. Accrued interest for the period October 1, Year 1 to January 1, Year 2, is $8,000. On January 1, Year 2, what amount should Oak report as bonds payable, net of discount? |
January 1, Year 2 is the issuance date of the bonds and on that date, the bonds will be reported at their issuance price of $388,000 (97% x $400,000) |
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Dec 31, Moss issued $1,000,000 of 11% bonds at 109. Each $1,000 bond was issued w/ 50 detachable stock warrants, each entitled the bondholder to purchase 1 share of $5 par common stock for $25. Immediately after issuance, market value of each warrant was $4. Dec 31, what amount should Moss record as discount or premium on issuance of bonds? |
Dr: Cash$ 1,090,000 Dr: Discount on bond 110,000 Cr: Bonds payable$ 1,000,000 Cr: APIC - Warrants 200,000 |
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A bond issued June 1, Yr 1, has interest payment dates of April 1 and October 1. Bond interest expense for Yr 1 is for a period of: a. Seven months. b. Four months. c. Six months. d. Three months. |
Seven months. Interest expense is recognized for the entire period from bond issuance (June 1) through the fiscal year end (December 31). |
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March 1, Yr 1, Somar issued 20-yr bonds at a discount. By Sep 1, Yr 6, bonds were quoted at 106 when Somar exercised its right to retire the bonds at 105. The amount is material and considered to be unusual in nature and infrequently occurring w/ respect to Somar. How should Somar report bond retirement on its Year 6 income statement under U.S. GAAP? |
An extraordinary loss. The settlement price is greater than the face value of the debt and the face value is greater than the book value. Therefore, the settlement price is greater than the book value and a loss would be recognized on the transaction. This loss would be classified as "extraordinary" because it meets the U.S. GAAP criteria. |
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Jan 31, Yr 2, Beau issued $300,000 maturity value, 12% bonds for $300,000 cash. The bonds are dated Dec 31, Yr 1, & mature Dec 31, Yr 11. Interest is paid semi-annually June 30 & Dec 31. What accrued interest payable should Beau report in its Sep 30, Yr 2 balance sheet? a. $9,000 b. $18,000 c. $24,000 d. $27,000
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Accrued interest payable on September 30, Year 2 is the interest owed since the June 30, Year 2 payment.
$300,000 × 12% × 3/12 = $9,000 |
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Jan 2, Yr 1, Gill issued $2,000,000 of 10-yr, 8% bonds at par. The bonds, dated Jan 1, Yr 1, pay interest semiannually on Jan 1 & July 1. Bond issue costs were $250,000. What amount of bond issue costs are unamortized at June 30, Yr 2 under GAAP? a. $237,500 b. $220,800 c. $212,500 d. $225,000
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$212,500. Bond issue costs are recorded as deferred charges, and amortized over the life of the related debt. Amortization usually follows the straight-line method. Amortization for 1 1/2 years should have been recorded. |
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Webb has outstanding a 7%, 10-year $100,000 face-value bond. The bond was originally sold to yield 6% annual interest. Webb uses the effective interest rate method to amortize bond premium. June 30, Yr 2, the carrying amount of the outstanding bond was $105,000. What amount of unamortized premium on bond should Webb report in June 30, Yr 3, B/S? |
$4,300. The unamortized premium is amortized over the life of the bond using the 6% yield rate.
Interest expense for period: $105,000 x 6% = 6,300 Interest Paid: $100,000 x 7% = 7,000 Premium Amortized: 7,000-6,300 = 700 Unamortized Premium = 5,000 - 700 = 4,300 |
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March 31, Ashley, bondholders exchanged convertible bonds for stock. Carrying amount of these bonds on Ashley's books was < market value but > par value of common stock issued. If Ashley used B/V method, which statements correctly states an effect of this conversion? a. Stockholders' equity is increased. b. An extraordinary loss is recognized. c. Additional paid-in capital is decreased. d. Retained earnings is increased.
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Stockholders' equity is increased. Under the book value method of exchanging convertible bonds for stock, the book value of the bonds is reallocated to the par value and the additional paid-in capital accounts of the common stock. Thus, stockholders' equity is increased. |
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Weald took advantage of market conditions to refund debt, the 5th refunding operation by Weald in last 4 years. The excess of carrying amount of old debt over the amount paid to extinguish it should be reported as a (an): a. Deferred credit to be amortized over life of new debt. b. Part of continuing operations. c. Extraordinary gain, net of income taxes. d. Extraordinary loss, net of income taxes. |
Many companies and agencies extinguish (or refund) long-term debt prior to maturity as a method of managing financial risk. In this case, the refunding is not considered an extraordinary event because it is not unusual and infrequent. The gain (retirement price less carrying amount of the old debt) will be included as part of continuing operations. |
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March 1, Yr 1, Evan issued $500,000 10% nonconvertible bonds at 103 due Feb 28, Yr 11. Each $1,000 bond was issued w/ 30 detachable stock warrants, each entitling the holder to purchase, for $50, 1 share of Evan's $25 par common stock. March 1, Yr 1, market price of each warrant = $4. What amount should bond issue proceeds increase stockholders' equity?
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Stockholders' equity is increased by the value of the warrants. There are 500 bonds with 30 warrants worth $4 each. 500 x 30 x $4 = $60,000. |
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Dec 1, Yr 1, Tigg gave Pod a $200,000, 12% loan. Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal & interest are due in 60 monthly installments of $4,450, beg. Jan 1, Yr 2. Repayments yield a 12% effective interest rate at a PV of $200,000 & 13.4% at a PV of $194,000. What accrued interest receivable should Tigg include in its Dec 31, Yr 1, B/S? |
$2,000 accrued interest receivable in December 31, Year 1 balance sheet. 200,000 x 12% x 1/12 = 2,000 |
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April 1, Yr 1, Saxe, purchased $200,000 face value, 9% Notes for $198,500, incl. accrued interest of $4,500. Notes mature July 1, Yr 2, & pay interest semiannually Jan 1 & July 1. Saxe uses SL amortization method. The notes were sold Dec 1, Yr 1 for $206,500, incl. accrued interest of $7,500. In its Oct 31, Yr 1 B/S, the carrying amount of this investment should be: |
$196,800 carrying amount of investment at 10/31/Year 1. |
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On June 1 of the current year, Cross Corp. issued $300,000 of 8% bonds payable at par with interest payment dates of April 1 and October 1. In its income statement for the current year ended December 31, what amount of interest expense should Cross report? |
Interest expense is calculated from the date the bond is issued. Interest would be calculated from June 1 - Dec 31 (7 months). $300,000 x 8% = $24,000 annual interest cost $24,000 / 12 = $2,000 per month $2,000 x 7 = $14,000 interest expense |
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Album issued 10-yr $200,000 debenture bonds Jan 2. Bonds pay interest semiannually. Album uses effective interest method to amortize premiums and discounts. Carrying value of the bonds on Jan 2 = $185,953. A J/E was recorded for the 1st interest payment on June 30, debiting interest expense for $13,016 & crediting cash for $12,000. What is the annual stated interest rate for the debenture bonds? |
12%.
Stated interest = Amount stated on bond: $12,000/200,000 = 6% x 2 = 12%. |
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Which of the following is generally associated with the terms of convertible debt securities? a. An interest rate < nonconvertible debt. b. A feature to subordinate the security to nonconvertible debt. c. A noncallable feature. d. An initial conversion price <the market value of the common stock at time of issuance. |
The interest rate on convertible debt is generally lower than nonconvertible debt because of the value of the conversion feature. |
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Which is reported as interest expense? a. Deferred compensation plan interest. b. Pension cost interest. c. Amortization of discount of a note. d. Interest incurred to finance a software development for internal use.
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Amortization of discount of a note. When a discount on a bond or note is amortized, the discount amortization increases interest expense for the period. |
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Jan 1, Stunt had outstanding convertible bonds w/ a face value of $1,000,000 & an unamortized discount of $100,000 accounted for by GAAP. That day, bonds were converted into 100,000 shares of $1 par stock. Market value on conversion date = $12/share. The transaction will be accounted for with B/V method. What amount will Stunt's stockholders' equity increase as a result of the conversion? |
$900,000. When the book value method is used to account for the conversion of bonds to stock, the stock issued is recorded at the carrying value of the bonds. In this problem, the bonds have a carrying value of $900,000 ($1,000,000 face value - $100,000 discount), so the 100,000 shares of stock will be recorded at $900,000, resulting in a $900,000 increase in stockholders' equity. |
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A company issued a bond w/ a stated interest rate < the effective interest rate on the date of issuance. The bond was issued on 1 of the interest payment dates. What should the company report on 1st interest payment date? a. An interest expense < the cash payment made to bondholders. b. A debit to the unamortized bond discount. c. A debit to the unamortized bond premium. d. An interest expense that is greater than the cash payment made to bondholders. |
An interest expense that is greater than the cash payment made to bondholders.
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A company issues bonds at 98, with a maturity value of $50,000. The entry the company uses to record the original issue should include which of the following? a. A credit to bonds payable of $49,000. b. A credit to bond premium of $1,000. c. A debit to bonds payable of $50,000. d. A debit to bond discount of $1,000. |
A debit to bond discount of $1,000.
Dr: Cash$ 49,000 Dr: Discount on bonds payable 1,000 Cr: Bonds payable$ 50,000
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What type of bonds in a particular bond issuance will not all mature on the same date? a. Debenture bonds. b. Serial bonds. c. Term bonds. d. Sinking fund bonds.
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Serial bonds. Serial bonds are bonds that mature in installments. |
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On July 28, Vent Corp. sold $500,000 of 4%, eight-year subordinated debentures for $450,000. The purchasers were issued 2,000 detachable warrants, each of which was for one share of $5 par common stock at $12 per share. Shortly after issuance, the warrants sold at a market price of $10 each. What amount of discount on the debentures should Vent record at issuance? |
$70,000. When bonds are issued with detachable warrants, the purchase price must be allocated between the bonds and the warrants. Because only the fair value of the warrants is known, that fair value is allocated to APIC - Warrants and the remaining purchase price is allocated to the bonds. |
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Which characterizes convertible debt under U.S. GAAP? a. The issuer's stock price is less than market value when the debt is converted. b. No value is assigned to the conversion feature when convertible debt is issued. c. The holder of the debt must be repaid with shares of the issuer's stock. d. The transaction should be recorded as the issuance of stock. |
Under U.S. GAAP, because the conversion feature cannot be sold or transferred separate from the bonds themselves, no value is assigned to the conversion feature when the bonds are issued. |
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In Yr 1, Lee acquired, at a premium, Enfield, 10-yr bonds classified as a held-to-maturity investment. At Dec 31, Yr 2, Enfield's bonds were quoted at a small discount. Which of the following situations is the most likely cause of the decline in the bonds' market value? a. Interest rates have increased since Lee purchased the bonds. b. Enfield is expected to call the bonds at a premium, which is less than Lee's carrying amount. c. Interest rates have declined since Lee purchased the bonds. d. Enfield issued a stock dividend. |
Interest rates have increased since Lee purchased the bonds. If interest rates have increased, then the bonds' interest rate would be less attractive to investors now than when the bonds were originally issued, causing a decline in the bonds' market value. |
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Jent purchased bonds at discount of $10,000. Jent sold these bonds at a premium of $14,000. At sale date, amortization = $2,000. What should Jent report as gain on sale? a. $24,000 b. $26,000 c. $22,000 d. $12,000
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he bonds' book value equals the bond face value less the unamortized discount. The unamortized discount = $10,000 - $2,000 = $8,000, so the book value equals face value - $8,000. The selling price of the bonds is face value + $14,000. The gain on the sale equals the selling price (face value + $14,000) minus the book value (face value - $8,000) = $22,000. |
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July 1, Yr 1, York purchased as a held-to-maturity investment $1,000,000 of Park, 8% bonds for $946,000, incl. accrued interest of $40,000. The bonds were purchased to yield 10% interest. The bonds mature Jan 1, Yr 8, & pay interest annually on Jan 1. York uses the effective interest method. In its Dec 31, Yr 1, B/S what is York's bond investment? |
$911,300. The carrying amount on December 31, Year 1, is $906,000 + $5,300 = $911,300. |
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April 1, Yr 1, Ward issued $750,000 of 10% nonconvertible bonds at 102 due March 31, Yr 11. Each $1,000 bond was issued w/ 40 detachable stock warrants, entitling the bondholder to purchase 1 share of Ward $10 par common stock for $25. April 1, Yr 1, market value of Ward's common stock was $20/share, & market value of each warrant was $4. What should Ward record as an increase in stockholders' equity? |
$120,000 is credited to "paid-in capital", (thus increasing stockholders' equity). Amount allocated is based upon FMV of "detachable" warrants at date of issuance. |
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When debt is issued at a discount, interest expense over the term of debt equals the cash interest paid: a. Plus discount. b. Plus discount plus par value. c. Minus discount minus par value. d. Minus discount. |
Plus discount. When debt is issued at a discount, interest expense over the term of the debt equals the cash interest paid plus amortization of the discount. The J/E:
Dr: Interest expense$ XXX Cr: Amortization of bond discount$ XXX Cr: Cash (or interest payable)XXX |
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Jan 1, Yr 1 a company issued a $50,000 face value, 8% five-yr bond for $46,139 that will yield 10%. Interest is payable June 30 & Dec 31. What is the bond carrying amount on Dec 31, Yr 1? a. $47,106 b. $46,139 c. $46,446 d. $46,768 |
$46,768. The carrying amount of the bond on December 31 will be equal to the $50,000 face amount of the bond less the unamortized bond discount |
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Jan 1, Yr 1, Cain issued 200 of its 9%, $1,000 bonds at 103. The bonds are dated Jan 1, Yr 1 & mature Jan 1, Yr 11. Interest is payable semiannually Jan 1 & July 1. Cain paid bond issue costs of $5,000. Cain Corp. uses IFRS. Jan 1, Yr 1, net carrying value of bond liability is: a. $211,000 b. $200,000 c. $201,000 d. $206,000 |
$201,000. Under IFRS, bond issue costs reduce cash received from bond issuance & are deducted from the carrying value of the liability. This bond was issued at a premium for $206,000 ($200,000 x 103%). The net premium on the bond is $1,000 ($6,000 premium on issuance - $5,000 bond issue costs). |
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Which of the following statements characterizes convertible debt under IFRS? a. Convertible bonds are generally issued for less than face value. b. The conversion feature can be traded separately. c. An equity component should be recognized upon issuance = difference between proceeds received and the FV of the bond liability. d. There is no recognition of conversion feature at issuance because it is difficult to determine the value of the conversion feature. |
Under IFRS, both a liability (bond) and an equity component (conversion feature) should be recognized when convertible bonds are issued. The bond liability is valued at fair value, with the difference between the actual proceeds received and the fair value of the bond liability recorded as a component of equity. |
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When purchasing a bond, the present value of the bond 's expected net future cash inflows discounted at the market rate of interest provides what information about the bond? a. Yield. b. Price. c. Par. d. Interest. |
Price. |
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When the effective interest method of amortization is used for bonds issued at a premium, the amount of interest payable for an interest period is calculated by multiplying: a. Face value of the bonds at the beginning of the period by the contractual interest rate. b. Carrying value of the bonds at the beginning of the period by the effective interest rates. c. Carrying value of the bonds at the beginning of the period by the contractual interest rate. d. Face value of the bonds at the beginning of the period by the effective interest rates. |
The interest payable on a bond is calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual interest rate. |
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Feb 1, Yr 1, Davis issued 12%, $1,000,000 face amount, 10-year bonds for $1,117,000. Davis reacquired all of these bonds at 102, plus accrued interest, May 1, Yr 4 & retired them. Unamortized bond premium on that date was $78,000. What was Davis' gain on the bond retirement? |
Bonds at face value$ 1,000,000 Add: Unamortized bond premium78,000 Carrying value of bonds to be retired1,078,000 Less: Cash paid (1,000 bonds at 102)(1,020,000) Gain on bond retirement$ 58,000 |
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Eddy Corp. incurred these costs in connection with the issuance of bonds: Printing and engraving $ 30,000 Legal fees 160,000 Fees paid to independent accountants for registration information 20,000 Commissions paid to underwriter 300,000 What is recorded as deferred charge amortized over term of the bonds under GAAP? |
$510,000. Under U.S. GAAP, all costs associated with the issuance of bonds should be capitalized and amortized over the outstanding term of the bonds since issue. |
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Main issued bonds w/ detachable common stock warrants. Only the warrants had a known market value. Sum of the FV of the warrants and the face amount of the bonds exceeds the cash proceeds. This excess is reported as: a. Common stock subscribed. b. Premium on bonds payable. c. Discount on bonds payable. d. Contributed capital in excess of par-stock warrants.
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Discount on bonds payable. Rule: Allocate amounts separately to debt & detachable warrants according to their FMV at date of issuance. The amount allocated to warrants is "paid-in capital." Any difference between the amount paid (proceeds) and the combination of FMVs of debt and warrants should be debited or credited to "discount or premium on bonds payable." |
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On January 1, Year 1, a company established a sinking fund in connection with an issue of bonds due on December 31, Year 10. At December 31, Year 5, the independent trustee held cash in the sinking fund account representing the annual deposits to the fund and the interest earned on those deposits. How should the sinking fund be reported in the company's balance sheet at December 31, Year 5? |
a. The entire balance in the sinking fund account should appear as a noncurrent asset. b. The cash in the sinking fund should appear as a current asset. c.The entire balance in the sinking fund account should appear as a current asset. d. Only the accumulated deposits should appear as a noncurrent asset. |
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In open market transactions, Gold Corp simultaneously sold its long-term investment in Iron bonds & purchased its own outstanding bonds. The purchase of its own bonds is a material unusual and infrequent event for Gold Corp. The broker remitted the net cash from the 2 transactions. Gold's gain on the purchase of its own bonds exceeded its loss on the sale of the Iron bonds. Gold should report the: |
a. Net effect of the two transactions as an extraordinary gain. b. Net effect of the two transactions in income before extraordinary items. c. Effect of its own bond transaction as an extraordinary gain, and report the Iron bond transaction loss in income before extraordinary items. d. Effect of its own bond transaction gain in income before extraordinary items & report Iron bond transaction as an extraordinary loss. |
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July 1, Yr 1, after recording interest & amortization, York converted $1,000,000 of its 12% convertible bonds into 50,000 shares of $1 par value common stock. On the conversion date the carrying amount of the bonds was $1,300,000, the market value of the bonds was $1,400,000, & York's common stock was publicly trading at $30 per share. Using the B/V method, what A.P.I.C. should York record as a result of the conversion? |
$1,250,000. Under the book value method, A.P.I.C. = the excess of the bond's carrying value over the stock's par value less any conversion costs. No gain or loss is recognized. |
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Converge sold a $100,000 bond at 95 & incurred $3,000 of bond issuance costs. Which statement is correct, under IFRS? a. Discount of $8,000 is amortized using the effective interest method over life of the bond. b. Discount of $5,000 is amortized using the straight-line method over the life of the bond. c. A debit to cash is booked for $100,000. d. An asset is booked for $3,000. |
The discount of $8,000 is amortized using the effective interest method over the life of the bond. Under IFRS, bond issue costs are deducted from the carrying value of the liability and included in the debit entry to bond discount upon issuance. As part of the discount from par, bond issue costs are amortized over the life of the bond using the effective interest method. |
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On December 31, Year 1, Todd Corporation issued 500 of its 10%, $1,000 bonds at 105. Todd Corporation uses IFRS. The bonds were issued through an underwriter to whom Todd paid bond issue costs of $15,000. On the December 31, Year 1 balance sheet, Todd should report the bond liability at: |
$510,000. Under IFRS, bond issue costs reduce the cash received from the bond issuance and are deducted from the carrying value of the liability. |
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Septer Corporation issued 2,000 of its $1,000, 8% ten-year bonds dated July 1,Year 1 on September 1, Year 1, at a time when the market paid 9% for bonds of similar risk. The bonds were quoted at 94 and pay interest quarterly on September 30 and December 31. What were the total proceeds of the bond issue at the time of sale? |
$ 2,000,000 x 0.94 = 1,880,000 Interest paid per quarter ($2,000,000 × 8% divided by 4) = 40,000 Months expired (July and August) represent 2/3 of the quarter = 0.667 Accrued interest = 40,000 x 0.667 = 26,667 Total proceeds = $1,906,667 |
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On January 2, Vole Co. issued bonds with a face value of $480,000 at a discount to yield 10%. The bonds pay interest semiannually. On June 30, Vole paid bond interest of $14,400. After Vole recorded amortization of the bond discount of $3,600, the bonds had a carrying amount of $363,600. What amount did Vole receive upon issuing the bonds? |
$360,000. As the discount is amortized, the discount decreases and the carrying value of the bond increases. The carrying amount is $363,600 after recording amortization of $3,600. Therefore, the carrying amount before amortization is $360,000. |
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What type of bonds mature in installments? a. Term. b. Variable rate. c. Serial. d. Debenture. |
Serial bonds are pre-numbered bonds that the issuer may call and redeem a portion by serial number. |
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Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record? |
$302,000. No gain or loss is recognized at conversion. At conversion, the bond payable and discount are written off and common stock is credited at par. Additional paid in capital is credited for the excess of the bond's carrying value over the stock's par value. |
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If a premium on a bonds payable transaction is not amortized, what are the effects on interest expense and total stockholders' equity? Are they Overstated or Understated? |
Interest Expense: Overstated Total Stockholders' Equity: Understated The bond premium is amortized over the life of the bond with amortized amounts decreasing interest expense each period. If interest expense is not appropriately decreased, then interest expense will be overstated. The overstating of interest expense will lead to the understatement of net income, which understates of stockholder's equity. |
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On its Dec 31, Yr 1 B/S, Nilo reported bonds payable of $8 mil & related unamortized bond issue costs of $430,000 under GAAP. The bonds were issued at par. On Jan 2, Yr 2, Nilo retired $4,000,000 of the outstanding bonds at par plus a call premium of $100,000. This transaction is material to Nilo & is considered unusual & infrequent. Ignoring taxes, what should Nilo report in its Year 2 I/S as loss on extinguishment of debt? |
$315,000. Face value of bonds retired$ 4,000,000 Less pro rata unamortized bond issue costs (4,000,000/8,000,000 x 430,000) (215,000) Net carrying amount 3,785,000 Reacquisition price (4,000,000 + 100,000) 4,100,000 Total$ (315,000) |
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Jan 2, Yr 1, Chard issued 10-yr convertible bonds at 105. Chard uses GAAP. During Yr 4, the bonds were converted into common stock w/ aggregate par value = total face amount of the bonds. At conversion, market price of Chard's stock was 50% above par value. Jan 2, Yr 1, cash proceeds from the issuance of the convertible bonds should be reported as: |
a. Contributed capital for the portion of the proceeds attributable to the conversion feature and as a liability for the balance. b. A liability for the entire proceeds. c. Contributed capital for the entire proceeds. d. A liability for the face amount of the bonds and contributed capital for the premium over the face am |
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Jan 2, Yr 1, Chard issued 10-yr convertible bonds at 105. Chard uses GAAP. During Yr 4, the bonds were converted into common stock w/ aggregate par value = total face amount of the bonds. At conversion, market price of Chard's stock was 50% above par value. Depending on whether the BV or MV method was used, Chard would recognize gains or losses on conversion when using the: |
Book value method Market value method a. Neither gain nor loss Gain b. Neither gain nor loss Loss c. Either gain or loss Loss d. Either gain or loss Gain |
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Ray Corp. issued bonds with a face amount of $200,000. Each $1,000 bond contained detachable stock warrants for 100 shares of Ray's common stock. Total proceeds from the issue amounted to $240,000. The market value of each warrant was $2, and the market value of the bonds without the warrants was $196,000. The bonds were issued at a discount of: |
$678 discount on bonds payable. Allocate amt received separately to bonds & detachable warrants according to their relative FV's at date of issuance. Amount allocated to detachable warrants is paid-in capital. Difference between amt allocated to the bonds & face value (par) is debited or credited to "discount or premium on bonds payable." |
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A 15-yr bond was issued in Yr 1 @ discount. In Yr 11, a 10-yr bond was issued @ face amount w/ proceeds used to retire the 15-yr bond @ its face amount. Net effect of the Year 11 bond transactions was to increase long-term liabilities by the excess of the 10-year bond's face amount over the 15-year bond's:
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a. Carrying amount less the deferred loss on bond retirement. b. Carrying amount. c. Face amount. d. Face amount less the deferred loss on bond retirement.
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Market price of a bond issued at a discount is the PV of its principal amount at the market (effective) rate of interest: a. Plus the PV of all future interest payments at the rate of interest stated on the bond. b. Plus the PV of all future interest payments at the market (effective) rate of interest. c. Less the PV of all future interest payments at the market (effective) rate of interest. d. Less the PV of all future interest payments at the rate of interest stated on the bond. |
b. Plus the present value of all future interest payments at the market (effective) rate of interest. |
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An issuer of bonds uses a sinking fund for the retirement of the bonds. Cash was transferred to the sinking fund and subsequently used to purchase investments. The sinking fund: I. Increases by revenue earned on the investments. II. Is not affected by revenue earned on the investments. III. Decreases when the investments are purchased. |
I only. The sinking fund increases by revenue earned on the investments. The sinking fund is used to retire bonds at a future date and cash is transferred to the sinking fund on a discounted basis to consider future revenue earned on the investments made with sinking fund assets. |
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Bonds with detachable stock warrants were issued by Flack Co. Immediately after issue the aggregate market value of the bonds and the warrants exceeds the proceeds. Is the portion of the proceeds allocated to the warrants less than their market value, and is that amount recorded as contributed capital? |
Less than warrant's market value: Yes Contributed Capital: Yes
The amount allocated to detachable warrants is recorded as contributed (additional paid-in) capital. The portion of the proceeds allocated to the warrants is recorded as contributed capital, & the amount will be < their market value cuz the total proceeds were less than the combined MVs of the bonds & warrants. |
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Dixon Co. incurred costs of $3,300 when it issued, on August 31, Year 1, 5-year debenture bonds dated April 1, Year 1. What amount of bond issue expense should Dixon report in its income statement for the year ended December 31, Year 1 under U.S. GAAP? |
Issue costs$ 3,300 Months to maturity [60-5 (Apr. 1 to Aug. 31)] = ÷ 55 Per month 60 Months outstanding (Sept. 1 to Dec. 31)× 4 4 months' expense$ 240 |
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Dec 31, of the current year, Wright placed $875,000 in an irrevocable trust. The trust's assets are used solely for satisfying obligations on Wright's 6%, $1,100,000, 30-year bond payable. Wright has not been legally released from its obligations under the bond agreement, but any additional liability is considered remote. This material event is considered unusual and infrequent for Wright. On Dec 31, of the current year, the bond's carrying amount was $1,050,000, & its MV was $800,000. What amt of extraordinary gain (loss) should Wright report in its current year I/S? |
ZERO. A debtor is relieved of its obligation to the creditor only by: Paying the creditor. Being released of the debt judicially or by the creditor. Considering debt as "extinguished" (defeasing debt) by placing cash in an irrevocable trust is not GAAP for "extinguishment of debt." |
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During current year, Lake issued 3,000 of its 9%, $1,000 face value bonds at 101 l/2. In connection w/ the sale of these bonds, Lake paid the following expenses: Promotion costs $20,000 Engraving and printing 25,000 Underwriters' commissions 200,000 What amount should Lake record as bond issue costs to be amortized over the term of the bonds under U.S. GAAP? |
$245,000. All costs associated with the issuance of bonds should be capitalized and amortized over the "outstanding" term of the bonds. |
