F4 Module 4

Question 1

asset retirement obligation

Answer 1

-exists when an asset is constructed and legal requirements to incur removal-type costs related to created asset
-recorded as a liability when the asset is put into service and reported as the PV of future obligation (estimated FV of liability)
-no expense is recognized initially
-ARO will increase value of asset and depreciation expense recorded over life of asset and be an expense to ARO

Question 2

calculating discount/premium of a bond issuance

Answer 2

1) PV of interest over life of bond = face value of bond * stated rate * PV of annuity for appropriate n and r
2) PV of principal of bond = PV of $1 for appropriate n and r
3) add together steps 1 and 2 to get total PV of bond
4) face value of bond - total PV of bond = discount/premium

Question 3

serial bonds

Answer 3

Bonds that mature in installments and not on one date

Question 4

Term bonds

Answer 4

Bonds that have a single fixed maturity date

Question 5

debentures

Answer 5

Unsecured corporate bonds
They are unsecured because they have no collateral to back it and thus more risky and have a higher interest rate due to possibility of company defaulting

Question 6

bond sinking fund

Answer 6

A fund that a company contributes cash to each period so that it has enough to pay of the bond at maturity

Question 7

bond indenture

Answer 7

-document describes contract between the issuer (borrower) and bond holders (lenders)

Question 8

face value (par value)

Answer 8

-face value is total dollar amount of the bond and the basis on which periodic interest is paid
-bonds issued at face (par) value when stated rate of interest = market rate of interest

Question 9

stated (nominal or coupon) interest rate

Answer 9

-the stated interest rate, the interest paid to investors in cash
-rate specified in bond contract

Question 10

market (effective) interest rate

Answer 10

-rate of interest actually earned by the lender (bondholder) and is the rate of return for comparable contracts on date bonds issued

Question 11

discount

Answer 11

-market rate > stated rate, bonds issued at discount, as such bonds sell for less than the face amount to make up for the lower return being provided
-difference between face value of bond and sales price of bond causes interest expense to be greater than cash paid to lenders

Question 12

premium

Answer 12

-market rate < stated rate, bonds will be issued at a premium because investor will pay more than face value due to higher return offered
-difference between face value and selling price of bond causes interest expense to be less than interest paid

Question 13

mortgage bonds

Answer 13

-bonds that are secured by real property

Question 14

collateral trust bonds

Answer 14

-secured bonds because they require collateral

Question 15

convertible bonds

Answer 15

-bonds that can be converted to common stock of debtor at option of lender

Question 16

nondetachable warrants

Answer 16

-convertible bond must be converted to capital stock

Question 17

detachable warrants

Answer 17

-bond is not given up upon conversion, only the warrants plus cash representing exercise price of warrants
-warrants can be bought and sold separately from bonds

Question 18

participating bonds

Answer 18

-bonds that not only have a stated rate of interest but participate in income if certain earnings levels are obtained

Question 19

term bonds

Answer 19

-bonds that have a single fixed maturity date
-entire principal is paid at the end of this term/period

Question 20

income bonds

Answer 20

-bonds that only pay interest if certain income goals are met

Question 21

zero coupon bonds

Answer 21

-“deep discount bonds” are bonds sold with no stated interest but at a discount and redeemed at the face value without periodic interest payments

Question 22

commodity backed bonds

Answer 22

-“asset linked bonds” are redeemable either in cash or stated volume of commodity, whichever is greater

Question 23

bonds payable

Answer 23

-recorded as a long-term liability at face value and adjusted to present value of their future cash outflows by
1) subtracting unamortized discounts OR
2) adding unamortized premiums
-bonds payable recorded at true present value at date of issuance based on market interest rate at the date

Question 24

bond facts

Answer 24

1) usually issued in 1,000s
2) price always quoted in 100s (% of par value)
3) indenture is a contract for purchase of a bond
4) coupon rate = stated interest rate on bond
5) bond interest = coupon rate * face. bonds generally pay interest semiannually
6) principal payoff is always full face amount
7) premium/discount is result of buyer and seller adjusting coupon rate to prevailing market rate of interest

Question 25

bond selling price

Answer 25

-when bond issued, selling price = sum of PV of future principal payment + PV of future periodic interest payments
-both cash flows are discounted at market rate of interest on date of issuance (lent to borrower)

Question 26

PV interest calculation

Answer 26

-use the PV of annuity table number to calculate PV of interest. Also watch for if the interest payments are annually or semiannual, as this impacts which PV annuity amt you use

Question 27

PV of principal of loan

Answer 27

-use the PV of $1 table number and use the same annual or semiannual table number used for interest

Question 28

unamortized discount

Answer 28

-unamortized discount on bonds payable is a contra-account to bonds payable
-presented on B/S as a direct reduction from face (par) value of bonds to arrive at bond’s carrying value at point in time
-unamortized discount will decrease as discount is amortized

Question 29

amortization of discount

Answer 29

-bond discount represents added interest to be paid to investors at bond maturity and amortized over the life of the bond
-amortization of discount increases interest expense each period
-amt of amortization is added to amount of cash paid at stated rate to obtain GAAP interest expense
Note: if zero coupon bond, cash paid could be 0.

Question 30

unamortized premium

Answer 30

-presented on B/S as direct addition to face (par) value of bonds to arrive at bond carrying value at point in time
-unamortized premium will decrease as the premium amortized

Question 31

amortization of premium

Answer 31

-bond premium represents interest paid in advance to borrower by lenders, then lenders will receive a return of this premium in the form of larger periodic interest payments (at stated rate)
-bond premium amortized over life of bond will decrease interest expense each period
-amortization of premium is subtracted from amount of cash paid at stated rate to obtain GAAP interest expense

Question 32

carrying value

Answer 32

-face value + unamortized premium OR face value - unamortized discount
-as bonds reach maturity, they get closer to face value amt so they equal each other when reach maturity
-carrying value of bond for discount increases to maturity as discount amortized
-carrying value of bond for premium decreases to maturity as premium amortized

Question 33

bond issuance costs

Answer 33

-transaction costs incurred when bonds issued
-ex. legal fees, accounting fees, underwriting commissions, printing
-bonds accounted for at amortized cost
-bond issuance costs accounted for
1) presented on B/S as direct reduction to carrying amt of bond, similar to bond discounts
2) when bonds issued, bond proceeds are recorded net of bond issuance costs
3) bond issuance costs amortized as interest expense over life of bond using effective interest method

Question 34

effective interest rate

Answer 34

-used to determine the interest expense for the period as the bond discount/premium and bond issuance costs are amortized
-it must be disclosed in footnotes

Question 35

deferred bond issuance costs

Answer 35

-bond issuance costs incurred before issuance of bonds are deferred on B/S until bond liability recovered
JE to record bond issuance costs
-Dr. Deferred bond issuance costs
Cr. Cash (amt of bond issuance costs at beg.)
-JE to record bond
Dr. Cash (carrying value of bond after discount)
Dr. Discount and bond issuance costs (discount + issuance costs)
Cr. Bonds payable (face value)
Cr. Deferred bond issuance costs (first entry above amt)

Question 36

par value bonds

Answer 36

1) market rate at issuance = coupon (stated rate) of bond
2) no amortization
3) interest expense = interest payable each period
4) no discount or premium on bond

Question 37

unamortized premium formula

Answer 37

premium (carrying value - face value of bond) - premium amortization (interest payable - interest expense)

Question 38

interest expense calc.

Answer 38

carrying value of bond (at premium or discount) * market rate * number of periods in the year (if not annual)

Question 39

interest payable calc.

Answer 39

face value of bond * coupon (stated rate) * number of periods in the year (if not annual)

Question 40

premium amortization calc.

Answer 40

interest payable - interest expense

Question 41

when bonds are being called on an interest date

Answer 41

when bonds are being called or redeemed on a date of interest, there is no accrual of interest at that date