Chapter 14: Long-Term Liabilities

Question 1

What is a bond?

Answer 1

Debt security with two promises: promise to pay back amount borrowed after some period of time (principal) and a promise to make periodic interest payments

Question 2

How are cash flows from a bond determined?

Answer 2

From the face amount of the bond and the stated rate of interest

Question 3

How is a bond’s value/price determined?

Answer 3

From the present value of the future cash flows

Question 4

Secured vs. Unsecured Bonds

Answer 4

Unsecured bonds are debentures and are more risky (no form of collateral), Secured bonds have collateral

Question 5

Term vs. Serial Bonds

Answer 5

Term bonds (scheduled payments), serial bonds (stagger payments)

Question 6

Callable Bonds

Answer 6

At the option of the company, principal can be paid early making it less attractive to investors

Question 7

Convertible Bonds

Answer 7

At option of investor, exchange the bond for some other security

Question 8

Commodity-backed bonds

Answer 8

At investor’s option, can take payment of principal in commodity

Question 9

Deep discount bond

Answer 9

Issued at interest rate significantly less than market rate

Question 10

Registered vs. Coupon Bonds

Answer 10

Registered (know who should be paid), Coupon (anyone who holds bond can redeem it)

Question 11

Income vs. Revenue Bonds

Answer 11

Income (only pay interest when have income), Revenue (government bonds that guarantee revenue of some project and only paid when revenue is made on that project)

Question 12

What drives the price at which debt is issued?

Answer 12

The market rate of interest plus risk

Question 13

What is the price of a bond?

Answer 13

The present value of future payments of principal and interest discounted at the market rate of interest on day of issue

Question 14

Formula for Bond Proceeds/Price

Answer 14

PV of single amount + PV of annuity

Question 15

When is a bond issued at a discount?

Answer 15

When the bond is issued at a price below its face value, market rate of interest is higher than the coupon rate

Question 16

When is a bond issued at a premium?

Answer 16

When a bond is issued at a price above its face value and the market rate of interest is lower than the coupon rate

Question 17

Calculation of discount or premium on bond

Answer 17

Face value - Proceeds = Discount, Proceeds - Face Value = Premium

Question 18

Recording of bond being issued at discount/premium

Answer 18

Discount on Bonds payable (contra account) debited, Premium on bonds payable (adjunct account) credited

Question 19

How are bonds recorded on the books?

Answer 19

At their face value

Question 20

Calculation of Book Value of Bond

Answer 20

Face Value +/- Premium/Discount

Question 21

How are premiums and discounts amortized?

Answer 21

Using the effective interest method

Question 22

Calculation of interest expense

Answer 22

Book value of the bond x the market rate of interest at issue date

Question 23

Calculation of amortization of the discount or premium

Answer 23

Cash interest paid - Interest Expense

Question 24

Method used when apportioning interest between periods

Answer 24

Straight Line Amortization (Number of months in the period/Months between payments)

Question 25

What is the market value of bonds at any point a function of?

Answer 25

Time remaining and market rate of interest

Question 26

Debt extinguishment

Answer 26

Paying off bond early

Question 27

Recording of debt extinguishment

Answer 27

Accrue interest to date of exchange, Bring amortization schedule up to date, and recognize gains and losses

Question 28

Process of debt being exchanged for non-cash assets

Answer 28

Value asset at discounted value of debt principle and interest unless there is a high degree of certainty about FMV of asset

Question 29

Are are notes payable valued?

Answer 29

At the present value f their future interest and principal cash flows

Question 30

How are discounts and premiums on notes amortized?

Answer 30

Over the life of the notes

Question 31

Deep discount notes

Answer 31

Bear no interest and are sold at discount substantially below principal amount

Question 32

Recording of deep discount note

Answer 32

Note recorded for principal value and discount for different in principal amount and proceeds

Question 33

How is the discount on notes payable amortized?

Answer 33

Using the effective interest method

Question 34

Recording of notes issued for property with stated interest rate

Answer 34

Record property at the PV of the note

Question 35

Recording of notes issued for property with no interest rate

Answer 35

Record property at fair value of asset and record discount for difference between fair value of asset and face value of note

Question 36

Installment notes

Answer 36

Payment consists of part principal and part interest

Question 37

Recording of installment notes

Answer 37

recognize interest expense and amortize principal at each payment

Question 38

How are installment notes amortized?

Answer 38

Directly, no premium or discount account