Deck 14: Bonds and Long-Term Notes

Question 1

Straight-line amortization of bond discount or premium:

A)Can be used for amortization of discount or premium in all cases and circumstances.
B)Provides the same amount of interest expense each period as does the effective interest method.
C)Is appropriate for deep discount bonds.
D)Provides the same total amount of interest expense over the life of the bond issue as does the effective interest method.

Answer 1

D

Question 2

An implicit or imputed rate of interest must be used when long term notes are issued at a stated rate of interest that is materially different than the market rate of interest.

Answer 2

True

Question 3

The specific provisions of a bond issue are described in a document called a bond indenture.

Answer 3

True

Question 4

Periodic interest expense is the stated interest rate times the amount of debt outstanding during the period.

Question 5

Most corporate bonds are:

A)Mortgage bonds.
B)Debenture bonds.
C)Secured bonds.
D)Collateral bonds.

Question 6

During the year, Hamlet Inc. paid $20,000 to have bond certificates printed and engraved, paid $100,000 in legal fees, paid $10,000 to a CPA for registration information, and paid $200,000 to an underwriter as a commission. What is the amount of bond issue costs?

A)$330,000.
B)$300,000.
C)$120,000.
D)$ 20,000.

Question 7

The interest expense on an installment note decreases with each periodic payment.

Question 8

Bonds will sell for a premium when the market rate of interest exceeds their stated rate.

Question 9

Amortization of discount on bonds payable results in interest expense that is less than the actual cash outflow.

Question 10

The initial selling price of bonds represents the sum of all the future cash outflows required by the obligation.

Question 11

Interest expense is:

A)The effective interest rate times the amount of the debt outstanding during the interest period.
B)The stated interest rate times the amount of the debt outstanding during the interest period.
C)The effective interest rate times the face amount of the debt.
D)The stated interest rate times the face amount of the debt.

Question 12

The method used to pay interest depends on whether the bonds are:

A)Registered or coupon.
B)Mortgaged or unmortgaged.
C)Indentured or debentured.
D)Callable or redeemable.

Question 13

The interest rate that is printed on the bond certificate is not referred to as the:

A)Stated rate.
B)Contract rate.
C)Nominal rate.
D)Effective rate.

Question 14

Bonds usually sell at their:

A)Maturity value.
B)Face value.
C)Present value.
D)Statistical expected value.

Question 15

Companies are not required to, but have the option to, value some or all of their financial assets and liabilities at fair value.

Question 16

If a company chooses the option to report its bonds at fair value, then it reports changes in fair value in its income statement.

Question 17

Paid-in capital is increased when bonds payable are issued with detachable stock purchase warrants.

Question 18

The rate of interest that actually is incurred on a bond payable is called the:

A)Face rate.
B)Contract rate.
C)Effective rate.
D)Stated rate.

Question 19

Premium on bonds payable is a contra liability account.

Question 20

The carrying value of zero-coupon bonds increases by the periodic amount of interest recognized.

Question 21

When the interest payment dates are March 1 and September 1, and the bonds are issued on July 1, the amount of interest expense reported in the December 31 income statement for the year of issue would be for:

A)Six months.
B)Four months.
C)Ten months.
D)Twelve months.

Question 22

What is the annual stated interest rate on the bonds?

A)3.5%
B)6%
C)7%
D)None of these is correct.This is the annual cash interest paid ($14,000), divided by the maturity (face) value of $200,000.

Question 23

A $500,000 bond issue sold for 98. Therefore, the bonds:

A)Sold at a discount because the stated rate of interest was lower than the effective rate.
B)Sold for the $500,000 face amount less $10,000 of accrued interest.
C)Sold at a premium because the stated rate of interest was higher than the yield rate.
D)Sold at a discount because the effective interest rate was lower than the face rate.

Question 24

When bonds are sold at a premium and the effective interest method is used, at each interest payment date, the interest expense:

A)Remains constant.
B)Is equal to the change in book value.
C)Increases.
D)Decreases.

Question 25

When bonds are sold at a premium and the effective interest method is used, at each subsequent interest payment date, the cash paid is:

A)Less than the effective interest.
B)Equal to the effective interest.
C)Greater than the effective interest.
D)More than if the bonds had been sold at a discount.

Question 26

When bonds are sold at a discount and the effective interest method is used, at each subsequent interest payment date, the cash paid is:

A)More than the effective interest.
B)Less than the effective interest.
C)Equal to the effective interest.
D)More than if the bonds had been sold at a premium.

Question 27

Bonds were issued at a discount. In the bond amortization schedule:

A)The interest expense is less with each successive interest payment.
B)The total effective interest over the term to maturity is equal to the amount of the discount plus the total cash interest paid.
C)The outstanding balance (book value) of the bonds declines eventually to face value.
D)The reduction in the discount is less with each successive interest payment.

Question 28

Bonds are issued on June 1 that have interest payment dates of April 1 and October 1. Bond interest expense for the year ended December 31, 2009, is for a period of:

A)Three months.
B)Four months.
C)Six months.
D)Seven months.The interest expense is for the time the bonds were outstanding during the reporting period - 7 months in this case.

Question 29

An amortization schedule for bonds issued at a premium:

A)Summarizes the amortization of the premium, a contra-asset account with a credit balance.
B)Is reported in the balance sheet.
C)Is a schedule that reflects the changes in the debt over its term to maturity.
D)All of these are correct.

Question 30

LPC calls the bonds at 103 immediately after the interest payment on 12/31/10 and retires them. What gain or loss, if any, would LPC record on this date?

A)No gain or loss
B)$3,717 gain
C)$6,000 loss
D)$2,283 loss The cash paid by LPC was 103% of $200,000 maturity (face) value, or $206,000.The liability removed is $203,717.The difference is the loss on the bond retirement, $2,283.

Question 31

When bonds are sold at a discount and the effective interest method is used, at each interest payment date, the interest expense:

A)Increases.
B)Decreases.
C)Remains the same.
D)Is equal to the change in book value.

Question 32

On January 1, 2009, Legion Company sold $200,000 of 10% ten-year bonds. Interest is payable semiannually on June 30 and December 31. The bonds were sold for $177,000, priced to yield 12%. Legion records interest at the effective rate. Legion should report bond interest expense for the six months ended June 30, 2009, in the amount of:

A)$ 8,850
B)$10,000
C)$10,620
D)$12,000 6% $177,000 = $10,620

Question 33

When bonds are sold at a premium, if the annual straight-line amortization amount is compared to the annual effective interest amortization amount over the life of the bond issue, the annual amount of the straight-line amortization of premium is:

A)Higher than the effective interest amount in the early years and less than the effective interest amount in the later years.
B)Less than the effective interest amount in the early years and more than the effective interest amount in the later years.
C)Higher than the effective interest amount every year.
D)Less than the effective interest amount every year.

Question 34

On January 1, 2009, Solo Inc. issued 1,000 of its 8%, $1,000 bonds at 98. Interest is payable semiannually on January 1 and July 1. The bonds mature on January 1, 2019. Solo paid $50,000 in bond issue costs. Solo uses straight-line amortization. The amount of interest expense for the year is:

A)$80,000.
B)$82,000.
C)$78,000.
D)$89,000.Interest consists of cash paid out, $80,000, plus $20,000/10 years.

Question 35

What is the effective interest rate on the bonds?

A)3%
B)3.5%
C)6%
D)7% This is interest expense x 2, divided by the previous outstanding liability balance.

Question 36

LPC issued the bonds:

A)At par.
B)At a premium.
C)At a discount.
D)Cannot be determined from the given information.

Question 37

When bonds are sold at a discount, if the annual straight-line amortization amount is compared to the annual effective interest amortization amount over the life of the bond issue, the annual amount of the straight-line amortization of discount is:

A)Higher than the effective interest amount every year.
B)Higher than the effective interest amount in the early years and less than the effective interest amount in the later years.
C)Less than the effective interest amount in the early years and more than the effective interest amount in the later years.
D)Less than the effective interest amount every year.

Question 38

Ordinarily, the proceeds from the sale of a bond issue will be equal to:

A)The face amount of the bond.
B)The total of the face amount plus all interest payments.
C)The present value of the face amount plus the present value of the stream of interest payments.
D)The face amount of the bond plus the present value of the stream of interest payments.

Question 39

A bond issue with a face amount of $500,000 bears interest at the rate of 10%. The current market rate of interest is 11%. These bonds will sell at a price that is:

A)Equal to $500,000.
B)More than $500,000.
C)Less than $500,000.
D)The answer cannot be determined from the information provided.When the market rate of interest is higher than the bonds' stated rate, the bonds will sell at a discount.

Question 40

For a bond issue that sells for more than the bond face amount, the effective interest rate is:

A)The rate printed on the face of the bond.
B)The Wall Street Journal prime rate.
C)More than the rate stated on the face of the bond.
D)Less than the rate stated on the face of the bond.

Question 41

Assuming that Auerbach issued the bonds for $255,369,000, what interest expense would it recognize in its 2009 income statement?

A)$0
B)$3,830,535
C)$5,107,380
D)$7,661,070 This is the issue price of $255,369,000 6% effective rate 3 mos./ 12 mos.

Question 42

On January 1, 2009, an investor paid $291,000 for bonds with a face amount of $300,000. The stated rate of interest is 8% while the current market rate of interest is 10%. Using the effective interest method, how much interest income is recognized by the investor in 2009 (assume annual interest payments and amortization)?

A)$23,280.
B)$29,100.
C)$24,000.
D)$30,000.$291,000 10% = $29,100

Question 43

On January 31, 2009, B Corp. issued $600,000 face value, 12% bonds for $600,000 cash. The bonds are dated December 31, 2008, and mature on December 31, 2018. Interest will be paid semiannually on June 30 and December 31. What amount of accrued interest payable should B report in its September 30, 2009, balance sheet?

A)$18,000.
B)$36,000.
C)$54,000.
D)$48,000.The interest payable at September 30, 2009, will be for the three month's interest that has accrued since the last interest was paid on June 30, 2009 ($600,000 12% 3/12 = $18,000).

Question 44

What is the carrying value of the bonds as of December 31, 2010?

A)$8,834,770.
B)$8,686,606.
C)$8,734,070.
D)$8,783,433.Semiannual effective rate = $345,639 / $8,640,967 = 4% Amortization Payment 4 = ($8,783,433 4%) $300,000 = $51,337
Carrying value = $8,783,433 + $51,337 = $8,834,770

Question 45

Assuming that Auerbach issued the bonds for $255,369,000, what would the company report for its net bond liability balance after its first interest payment on March 31, 2010, rounded up to the nearest thousand?

A)$252,369,000
B)$256,369,000
C)$256,300,000
D)$257,030,000.This is the beginning liability of $255,369,000 + interest accrued for six months (3% of issue price) cash paid of $6,000,000.

Question 46

What is the stated annual rate of interest on the bonds?

A)3%.
B)4%.
C)6%.
D)8%.($300,000 / $10,000,000) 2 = 6%

Question 47

Griggs Co. failed to amortize the premium on an outstanding five-year bond issue. What is the resulting effect on interest expense and the bond carrying value, respectively?

A)Understated, understated.
B)Understated, overstated.
C)Overstated, understated.
D)Overstated, overstated.

Question 48

Auerbach issued the bonds:

A)At par.
B)At a premium.
C)At a discount.
D)Cannot be determined from the given information.The effective interest rate is more than the stated rate.

Question 49

How much cash interest does Auerbach pay on March 31, 2010?

A)$ 6.0 million
B)$12.0 million
C)$ 9.0 million
D)$18.0 million This is $300 million 4% 6/12.

Question 50

What would be the total interest cost of the bonds over their full term?

A)$1,359,033.
B)$4,640,967.
C)$6,000,000.
D)$7,359,033.($300,000 2 10) + ($10,000,000 $8,640,967) = $7,359,033

Question 51

What is the stated annual rate of interest on the bonds?

A)3%.
B)4%.
C)6%.
D)8%.($400,000 / $10,000,000) 2 = 8%

Question 52

What is the interest expense on the bonds in 2010?

A)$800,000.
B)$680,759.
C)$342,961.
D)$119,241.Semiannual effective rate = $344,632 / $11,487,747 = 3% Interest expense = $341,261 + ($11,316,611 3%) = $680,759

Question 53

What would be the total interest expense recognized for the bond issue over its full term?

A)$ 6,512,253.
B)$ 8,000,000.
C)$11,256,109.
D)$11,487,747.($400,000 2 10) ($11,487,747 10,000,000) = $6,512,253

Question 54

Zero-coupon bonds

A)offer a return in the form of a deep discount off the face value.
B)result in zero interest expense for the issuer.
C)result in zero interest revenue for the investor.
D)are reported as shareholders' equity by the issuer.

Question 55

What is the effective annual rate of interest on the bonds?

A)3%.
B)4%.
C)6%.
D)8%.($344,632 / $11,487,747) 2 = 6%

Question 56

What is the interest expense on the bonds in 2010?

A)$700,700.
B)$600,000.
C)$351,337.
D)$100,700.Semiannual effective rate = $345,639 / $8,640,967 = 4% Interest expense = $349,363 + ($8,783,433 4%) = $700,700

Question 57

The market price of a bond issued at a discount is the present value of its principal amount at the market (effective) rate of interest

A)Less the present value 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 rate of interest stated on the bond.
C)Plus the present value of all future interest payments at the market (effective) rate of interest.
D)Less the present value of all future interest payments at the market (effective) rate of interest.

Question 58

Assuming that Auerbach issued the bonds for $255,369,000, what would the company report for its net bond liability balance at December 31, 2009, rounded up to the nearest thousand?

A)$252,369,000
B)$256,369,000
C)$256,200,000
D)$257,030,070.This is the beginning liability of $255,369,000 + interest accrued for three months (1.5% of issue price) interest payable of $3,000,000 ($300,000,000 4% 3/12).

Question 59

What is the effective annual rate of interest on the bonds?

A)3%.
B)4%.
C)6%.
D)8%.($345,639 / $8,640,967) 2 = 8%

Question 60

What is the carrying value of the bonds as of December 31, 2010?

A)$11,432,379.
B)$11,375,350.
C)$11,316,611.
D)$11,256,109.

Question 61

When the interest payment dates are March 1 and September 1, and notes are issued on July 1, the amount of interest expense to be accrued at December 31 of the year of issue would:

A)Not be required.
B)Be for six months.
C)Be for four months.
D)Be for ten months.

Question 62

On January 1, 2009, an investor paid $291,000 for bonds with a face amount of $300,000. The contract rate of interest is 8% while the current market rate of interest is 10%. Using the effective interest method, how much interest income is recognized by the investor in 2010 (assume annual interest payments and amortization)?

A)$23,280.
B)$25,140.
C)$29,100.
D)$29,610.[$291,000 + ($291,000 10%) ($300,000 8%)] 10% = $29,610

Question 63

Eagle Company issued ten-year bonds at 96 during the current year. In the year-end financial statements, the discount should be:

A)Deducted from bonds payable.
B)Added to bonds payable.
C)Included as an expense in the year of issue.
D)Reported as a deferred charge.

Question 64

Bond X and bond Y both are issued by the same company. Each of the bonds has a maturity value of $100,000 and each matures in 10 years. Bond X pays 8% interest while bond Y pays 9% interest. The current market rate of interest is 8%. Which of the following is correct?

A)Both bonds sell for the same amount.
B)Both X sells for more than bond Y.
C)Both Y sell for more than bond X.
D)Both bonds sell at a discount.

Question 65

The unamortized balance of discount on bonds payable is reported in the balance sheet as:

A)A prepaid expense.
B)An expense account.
C)A current liability.
D)A contra-liability.

Question 66

When an equipment dealer receives a long-term note in exchange for equipment, the present value of the future cash flows received on the notes:

A)Is treated as a current liability at the exchange date.
B)Is recorded as interest revenue at the exchange date.
C)Is recorded as interest receivable at the exchange date.
D)Is credited to sales revenue at the exchange date.

Question 67

AMC issues a note in exchange for a machine with no stated interest rate. In accounting for the transaction:

A)The machine should be depreciated over the note's term to maturity.
B)If fair values of the note and machine are unavailable, the note should be recorded at its present value, discounted at the market rate of interest.
C)Both the note and machine are recorded at the face amount of the note or the fair value of the machine, whichever is more clearly determinable.
D)The note is recorded at its face amount unless the fair value of the machine is readily available.

Question 68

Bonds payable should be reported as a long-term liability in the balance sheet of the issuing corporation at the:

A)Face amount price less any unamortized discount or plus any unamortized premium.
B)Current bond market price.
C)Face amount less any unamortized premium or plus any unamortized discount.
D)Face amount less accrued interest since the last interest payment date.

Question 69

When a long-term note is given in exchange for equipment, the amount considered as paid for the machine is:

A)The invoice price.
B)The wholesale price.
C)The present value of cash outflows discounted at the stated rate.
D)The present value of the note payments discounted at the market rate.

Question 70

Liberty Company issued ten-year bonds at 105 during the current year. In the year-end financial statements, the premium should be:

A)Reported as an intangible asset.
B)Included in revenue for the year of sale.
C)Deducted from bonds payable.
D)Added to bonds payable.

Question 71

Pierce Company issued 11% bonds, dated January 1, with a face amount of $800,000 on January 1, 2009. The bonds sold for $739,816 and mature in 2028 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Pierce determines interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2009, the fair value of the bonds was $730,000. Pierce's earnings for the year will include:

A)A gain from change in the fair value of debt of $10,617.
B)A loss from change in the fair value of debt of $10,617.
C)A gain from change in the fair value of debt of $10,204.
D)A loss from change in the fair value of debt of $10,204.

Question 72

On January 1, 2009, Zebra Corporation issued 1,000 of its 8%, $1,000 bonds at 98. Interest is payable semiannually on January 1 and July 1. The bonds mature on January 1, 2019. Zebra paid $50,000 in bond issue costs. Zebra uses the straight-line amortization method. What is the bond carrying value reported in the December 31, 2009, balance sheet?

A)$1,045,000.
B)$1,040,000.
C)$987,000.
D)$982,000.$980,000 + [($1,000,000 $980,000) 1/10] = $982,000 Bond issue costs are reported and amortized separately.

Question 73

In each succeeding payment on an installment note:

A)The amount of interest paid increases.
B)The amount of principal reduction increases.
C)The amount of interest paid is unchanged.
D)The amounts paid for both interest and principal increase proportionately.

Question 74

Cramer Company sold 5-year, 8% bonds on October 1, 2009. The face amount of the bonds was $100,000, while the issue price was $102,000. Interest is payable on April 1 of each year. The fiscal year of Cramer Company ends on December 31. How much interest expense will Cramer Company report in its December 31, 2009, income statement (assume straight-line amortization)?

A)$ 2,000.
B)$ 1,900.
C)$ 1,778.
D)$ 2,040.

Question 75

Crawford Inc. has bonds outstanding during a year in which the market rate of interest has risen. Crawford elected the fair value option for the bonds upon issuance. What will the company report for the bonds in its income statement for the year?

A)Interest expense and a gain.
B)Interest expense and a loss.
C)A gain and no interest expense.
D)A loss and no interest expense.

Question 76

To evaluate the risk and quality of an individual bond issue, savvy investors rely heavily on:

A)Bond ratings provided by financial investment services such as Moody's.
B)Newspaper articles.
C)Bond interest payments.
D)The company's audit report.

Question 77

The times interest earned ratio indicates

A)the margin of safety provided to creditors.
B)the extent of "trading on the equity" or financial leverage.
C)profitability without regard to how resources are financed.
D)the effectiveness of employing resources provided by owners.

Question 78

Which of the following indicates the margin of safety provided to creditors?

A)Rate of return on shareholders' equity.
B)Times interest earned ratio.
C)Gross margin.
D)Debt to equity ratio.

Question 79

Bond X and bond Y both are issued by the same company. Each of the bonds has a maturity value of $100,000 and each pays interest at 8%. The current market rate of interest is 8% for each. Bond X matures in 7 years while bond Y matures in 10 years. Which of the following is correct?

A)Both bonds sell for the same amount.
B)Both bonds sell for more than $100,000.
C)Bond X sells for more than bond Y.
D)Bond Y sells for more than bond X.

Question 80

On June 30, 2009, Hardy Corporation issued $10 million of its 8% bonds for $9.2 million. The bonds were priced to yield 10%. The bonds are dated June 30, 2009, and mature on June 30, 2016. Interest is payable semiannually on December 31 and July 1. If the effective interest method is used, by how much should the bond discount be reduced for the 6 months ended December 31, 2009?

A)$32,000
B)$40,000
C)$46,000
D)$60,000 5% $9.2 million = $460,000
4% $10 million = $400,000
$460,000 400,000 =$60,000