CPA FAR CH 11 Bonds

Question 1

Bonds issued at a premium

Answer 1

when the stated or contract rate of interest exceeds the market rate, the bonds will sell for more than maturity value (more than face or par) = bond premium

Question 2

bonds issued at a discount

Answer 2

when the stated or contract rate is below the market rate, bonds will sell for less than maturity value (less than face or par)

Question 3

bond issuance costs

Answer 3

there are legal and registration issues for issuing bonds

most companies incur bond issuance costs b/c they do not issue bonds every day or every year

Ex Goldman Sachs finds the bond investor for the issuer

Question 4

bond issuance costs include

Answer 4

fees paid to underwriters and other costs directly associated with issuing the bond

direct and indirect costs associated with issuing bonds such as fees paid to underwriters, legal fees, accounting fees, and other costs (registration costs) attributable to bond issuance process

Question 5

bond issuance costs should be accounted for as

Answer 5

as an addition to the bond discount or offset to bond premium

they get amortized along with bond discount or premium in same account

Question 6

How are unamortized bond issuance costs presented on the balance sheet under US GAAP?

Answer 6

a reduction to the carrying value of the bond liability

unamortized bond issuance costs are deducted from the carrying amount of the bond liability= they are not presented as separate assets or equity

they directly reduce the bond liability on the balance sheet
Ex
LT Debt:
Principal bond payable $100,000
less unamortized discount and bond issuance costs ($9,361)
carrying value: $90,639

Question 7

If the bond issuance costs are not amortized, how does it affect the financial statements under US GAAP?

Answer 7

overstates Net income

if bond issuance costs are not properly amortized over the term of the bond, the expenses associated with these costs will not be recognized in the correct periods. This could result in overstating the net income in those periods b/c an expense that should have been recognized is not.

it would not affect the reported amount of the bond liability as these costs are already deducted from the carrying amount of the bond at issuance

Question 8

Accrued interest: bonds

Answer 8

interest payments on bonds are generally made semiannually (see bond indenture)

Bonds sold between payment dates require additional entries for accrued interest at the time of the sale

the amount of interest accrued since the last interest payment date is added to the price of the bond

purchaser pays interest up front and is reimbursed at the next interest payment date for the current period

Question 9

Year end bond interest accrual

Answer 9

when the date of a scheduled interest payment and the issuer’s period end= do NOT agree = must accrue

DR interest expense
CR interest payable

Question 10

Bonds not issued at par: Y/E accrual

Answer 10

if bonds are not issued at par, the period end accrual must take into account a prorated share of the discount or premium

Question 11

Bonds

Answer 11

long term debt obligations used to raise cash for growth and expansion

must pay back the investor with interest

Question 12

face value

Answer 12

total dollar amount of the bond, usually $1,000 is the face value

if 100 bonds are issued at $1,000 = face value of $100,000 which is the amount due to be paid back to the bondholders and it is the basis for interest calculation

Question 13

face vs carrying amount

Answer 13

Face value $100,000

if sold at a discount (sold at 99), carrying amount $99,000
if sold at a premium (sold at 104), carrying amount $104,000

Question 14

early extinguishment of a bond

Answer 14

paid off early, need to consider premium or discount as there may be a gain or loss

Question 15

bond indenture: engagement letter

Answer 15

the bond indenture is the contract (prepared in advance) that describes the arrangement between the issuer of the bonds and the bondholders.

The bond indenture contains the stated rate or coupon rate of interest.

Whether the bonds are callable, can be retired early by the issuer, is on the bond indenture.

It includes sinking fund requirements, dates of interest payments and if the bond is convertible.

Question 16

coupon rate = stated rate

Answer 16

also known as the nominal rate

interest rate to be paid to investors

coupon rate = stated on the bond indenture

bond always pays coupon rate regardless of what the market rate is

Question 17

market rate

Answer 17

rate of interest actually earned by the bondholders and is the rate of return for comparable bonds on the date the bond is issued.

market rate determines the selling price for the bond = NOT known in advance

Question 18

bond rating

Answer 18

all bonds have a rating such as AA, bb, bb+, and on the date the bonds are issued, all bb rated bonds earned 9%, for example

if the market rate = 9%, a bond issuer with a 10% stated rate bond will issue at a premium to the market rate of interest (sells at a premium= above face value)

if market rate = 11%, and the stated rate = 10% = issued at a discount

Question 19

if bond is callable

Answer 19

an issuer can retire callable bonds before maturity at a specified price

Question 20

if a bond is redeemable

Answer 20

the bondholder can require the issuer retire the bond early

Question 21

term bonds

Answer 21

are bond issues that mature on a single date

the entire principal is paid at the end of a specific term

Question 22

serial bonds

Answer 22

are pre-numbered bonds that the issuer may call and extinguish a portion by serial number, often annually

serial bonds mature in installments on different dates, the same date each year across a # of years

Question 23

debenture bonds

Answer 23

unsecured bonds, claims against general assets of a corp, not secured by specific assets of a corporation but a claim against the general assets of a corporation

debenture bonds may be serial or term bonds

Question 24

secure bonds

Answer 24

opposite of debenture bonds as secure bonds have specific assets to guarantee the debt

secure bonds may be serial or term bonds

Question 25

zero coupon bonds

Answer 25

zero coupon bonds are also known as deep discount bonds

they are sold with no stated interest but rather at a deep discount from the face value and are redeemed at the face value without periodic interest payments

all interest is paid at maturity, but each year interest expense is recognized (although not paid)

Question 26

income bonds

Answer 26

bonds that only pay interest if certain income objectives are met

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

Question 27

commodity backed bonds

Answer 27

commodity backed bonds asset linked bonds, bonds that redeemable either in cash or in a stated volume of commodity whichever is greater

Question 28

bonds payable issued with scheduled maturities at variable dates are called:
serial bonds
debenture bonds
term bonds

Answer 28

serial bonds

Question 29

Balance sheet Andrews Corp:
1. $700,000 bonds with $100,000 maturing annually beginning in 2023, interest rate 10%
2. $250,000 bonds due in 2020, 9.5% interest
3. $175,000 commodity backed bonds due in 2030, 9.75% interest

which are debenture bonds?

Answer 29

debenture bonds =
1. $700,000 bonds with $100,000 maturing annually beginning in 2023, interest rate 10%
2. $250,000 bonds due in 2020, 9.5% interest

debenture bonds are unsecured, secured only be general assets of a corp

if specific collateral to back them up = secured bonds

Question 30

Balance sheet Andrews Corp:
1. $700,000 bonds with $100,000 maturing annually beginning in 2023, interest rate 10%
2. $250,000 bonds due in 2020, 9.5% interest
3. $175,000 commodity backed bonds due in 2030, 9.75% interest

which are term bonds?

Answer 30

2. $250,000 bonds due in 2020, 9.5% interest
3. $175,000 commodity backed bonds due in 2030, 9.75% interest
4. serial bonds
5. term and unsecured
6. term and secured

Question 31

what type of bonds in a particular bond issuance will NOT all mature on the same date?
1. serial bonds
2. sinking fund bonds
3. term bonds
4. debenture bonds

Answer 31

Correct: 1. serial bonds = will not all mature on the same date; they mature in installments

Incorrect:
denture = unsecured corp bonds
term bonds = single fixed maturity date
bond sinking fund= fund that a company contributes cash to each period so that it has enough to pay off the bond at maturity

Question 32

which is correct?
1. debenture = unsecured corp bonds
2. callable bonds are neither term bonds nor serial bonds
3. bond sinking fund= cannot be used to pay off a callable bond
4. serial bonds = bonds that have a single fixed maturity date

Answer 32

1. debenture = unsecured corp bonds (only backed by good faith and credit)

Question 33

bonds with a single fixed maturity date:
1. serial bonds
2. term bonds
3. debenture bonds
4. callable bonds

Answer 33

2. term bonds = fixed single maturity date

Question 34

which describes callable bonds?
1. bonds secured by specific assets of a corp
2. bonds that can be exchanged for shares of common stock

Answer 34

Neither!

1. secured bonds
2. convertible bonds

Question 35

Each would be in the bond indenture agreement except?
1. whether bonds are secured or unsecured
2. whether bonds are term or serial
3. amount to be paid back at maturity
4. issue price of bonds

Answer 35

4. issue price of bonds

market rate not known in advance = only known at date of issuance

Question 36

which rate does not appear in the bond indenture agreement?
1. coupon rate
2. stated rate
3. nominal rate
4. yield rate

Answer 36

4. yield rate = market rate and not known in advance

Question 37

what is found in bond indenture agreement?

Answer 37

stated rate
face value
dates of interest payments
whether bond is callable, convertible
if sinking fund requirements

Question 38

Bondholders of Asti Corp would be considered unsecured creditors of Asti Corp and grouped with other unsecured creditors in the vent of Asti Corp’s bankruptcy if the bondholders of Asti Corp purchased
1. debentures
2. bonds only by credit of Asti Corp

Answer 38

Both!

backed only be credit of issuing firm and not secured by any specific assets = greater risk vs secured bonds

Question 39

bond sinking fund

Answer 39

to avoid a cash shortage at the time of debt repayment, a company may build up a separate cash sinking fund

bond sinking fund = 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

Bond sinking funds are accounted for in their own account including investments plus revenues less expenses

Question 40

NCA: bond sinking fund

Answer 40

generally, a noncurrent restricted asset on financial statement of issuer

it is a current asset only to the extent that it offsets a current liability

Question 41

Jan 1, Yr 1, company established a sinking fund in connection with an issue of bonds due Dec, 31, Yr 10.

Dec 31, Yr 5, the independent trustee held cash in the sinking fund account representing the annual deposits to the fund and interest earned on those deposits.

How should the sinking fund be reported B/S for Dec 31, Yr 5?

Answer 41

the entire balance of the sinking fund account should appear as a NCA, noncurrent asset

Question 42

troubled debt restructuring

Answer 42

mortgage lenders and credit card companies sometimes make concessions rather than write off a bad debt

this increases the likelihood of payment, but these concessions would not be offered under normal circumstances (except to avoid default or write off)

Question 43

troubled debt restructuring: acceptable terms to avoid a write off

Answer 43

the creditor will contact the debtor and let them know acceptable terms often involving forgiveness of penalties and interest, spreading payments over a longer term, and reduced interest rates

for the creditor, the objective is to maximize the recovery of investment

this is often the result of negotiation and legal proceeding between parties

Question 44

which of the following is correct regarding troubled debt restructuring?
1. for the creditor, the objective is to minimize the recovery of the investments
2. concessions made by the creditor normally include reduced interest rates

Answer 44

Incorrect: 1. objective is to maximize recovery

Correct: 2. concessions made by the creditor normally include reduced interest rates

Question 45

with regard to troubled debt restructuring, creditors typically make which of the following concessions in order to minimize the risk of bad debt write off?
1. extension of maturity dates
2. reduction of accrued interest

Answer 45

Both!

Question 46

troubled debt restructuring is often the result of
1. legal proceedings
2. negotiations between debtor and creditor
3. large debt write offs in the previous year

Answer 46

All of the above!

Question 47

accounting for restructuring: transfer of asset

Answer 47

several ways for the debtor to get out of the full amount owed:
1. transfer of assets- debtor transfers an asset to the creditor in exchange for debt relief= fair value of the asset is transferred

Adjusting the asset, up or down, to fair value (from book value) = represents ordinary gain or loss

Ex Asset fair value = $450,000
less basis ($360,000)
ordinary gain on transfer of an asset $90,000

the debt was $560,000 ($500,000 plus $60,000 accrued interest)
less fair value of given asset ($450,000)
restructuring gain $110,000

journal entry:
DR Notes payable $500,000
DR Interest payable $60,000
CR Land $360,000
CR Gain on disposal of land $90,000
Gain on restructuring $110,000 = debt discharged

total gain = $200,000

Question 48

with regard to troubled debt, the restructuring gain is the difference between the:

Answer 48

liability and the asset’s fair value and may NOT be extraordinary

Question 49

troubled debt restructuring: transfer of equity

Answer 49

instead of transfer of assets, the debtor could choose to offer the creditor a piece of the debtor’s corp, an equity interest