Flashcards in FAR 25 - LT Debt (Financial Liab) 2 - Bond Accounting Deck (65):
How to determine issue price????
The issue price for one $1,000 face value bond is the present value of all future payments discounted at the yield rate of 9%.
Issue price = $1,000(.422) + .06($1,000)(6.418) = $807
On January 2, 2005, West Co. issued 9% bonds in the amount of $500,000, which mature on January 2, 2015. 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, 2005 balance sheet, what amount should West report as bonds payable?
This question is vague. The question asks for the amount reported as bonds payable. Bonds payable, the account, is always reported at face value. The question should have asked for the net reporting, after subtracting the bond discount. This solution provides that answer, which is the officially correct answer.
The discount recorded at issuance is $30,500 ($500,000 - $469,500).
The journal entry for recognizing interest on June 30, 2005 helps to visualize the computation of the ending liability.
dr. Interest expense (.10(1/2)$469,500) 23,475
cr. Bond discount 975
cr. Interest payable (.09(1/2)$500,000) 22,500
Bonds payable $500,000
Less unamortized bond discount $30,500 - $975
Equals net book value of bonds $470,475
A company issued a bond with a stated rate of interest that is less than the effective interest rate on the date of issuance. The bond was issued on one of the interest payment dates. What should the company report on the first interest payment date?
A. An interest expense that is less than the cash payment made to bondholders.
B. An interest expense that is greater than the cash payment made to bondholders.
C. A debit to the unamortized bond discount
D. A debit to the unamortized bond premium
B. When the yield rate (effective interest rate) exceeds the stated or coupon rate, the bond sells at a discount. For example, the only way a 5% bond can yield 6% is to sell below face value. The discount represents interest expense over and above the periodic cash interest paid because the full face value is paid at maturity. The discount is recorded as debit contra account to bonds payable. This extra amount of interest is recognized by amortizing the discount recorded at issuance. The journal entry for periodic interest is: dr. Interest Expense, cr. Discount, cr. Cash. In this way, interest expense exceeds the cash interest paid at each interest payment date.
On May 1, 2002, Bolt Corp. issued 11% bonds in the face amount of $1,000,000, which mature on May 1, 2012.
The bonds were issued to yield 10%, resulting in bond premium of $62,000. Bolt uses the effective interest method of amortizing bond premium. Interest is payable semiannually on November 1 and May 1.
In its October 31, 2002 balance sheet, what amount should Bolt report as unamortized bond premium?
As of October 31, one six-month period has ended and interest must be recognized. Only the cash interest has not been paid because it is due the next day.
The amortization of the premium is dependent on the amount of interest expense recognized. Under the effective interest method, the interest expense on October 31 is based on the yield rate and the beginning book value at May 1. The beginning book value equals the face value plus the premium.
October 31, 2002
dr. Interest expense ($1,000,000 + $62,000)(.10)(1/2) 53,100
dr. Bond premium 1,900
cr. Iterest payable ($1,000,000)(.11)(1/2) 55,000
Unamortized bond premium = $62,000 - $1,900 = 60,100.
When you are given the present value of $1, how can you determine what the future value of $1 is?
The future value of $1 is the reciprocal of the present value of $1.
Ex: PV $1 - discounted at 10% is .826 for 2 periods. $10,00 invested will accumulate to $10,000(1/.826) = $12,107 in two years.
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 the
A. Face value of the bonds at the beginning of the period by the contractual interest rate.
B. This is the face value of the bonds at the beginning of the period by the effective interest rate.
C. Carrying value of the bonds at the beginning of the period by the contractual interest rate
D. Carrying value of the bonds at the beginning of the period by the effective interest rate
A. The amount of interest paid each period on a bond issue is the product of the total face value and the contractual rate. A 4%, $1,000 bond pays $40 interest per year, for example. This answer is the same regardless of the amortization method used.
The amount to report as interest expense is the product of the beginning book value of the bonds and the yield rate.
When a bond is purchased, 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. The bond price is the present value of the future cash payments to be paid by the issuer over the bond term. These payments are (1) the face value paid at maturity and (2) the interest payments. Each interest payment is the product of the coupon rate for the appropriate portion of a year (usually six months) and the face value. The stream of interest payments is an annuity. Both the single payment (face value) and the annuity are discounted at the yield or market rate of interest. The result is the bond price.
Album Co. issued 10-year $200,000 debenture bonds on January 2. The bonds pay interest semiannually. Album uses the effective interest method to amortize bond premiums and discounts. The carrying value of the bonds on January 2 was $185,953. A journal entry was recorded for the first interest payment on June 30, debiting interest expense for $13,016 and crediting cash for $12,000. What is the annual stated interest rate for the debenture bonds?
The stated rate determines the cash interest paid. $12,000/$200,000 = 6% for the six-month period, or 12% for the annual period. The stated rate is applied to the face value of the bonds, regardless of their price at issuance.
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 market (effective) rate of interest.
B. This is less 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. Plus the present value of all future interest payments at the rate of interest stated on the bond
C. This answer is true if the bond is issued at face value, discount, or premium.
The issue or market price of a bond at date of issuance is the present value of all future payments using the market (effective, yield) rate. The interest payments are an important part of the total return to the investor. The present value of only the face value would often be 1/2 or less of the total present value of the bond.
On January 1, a company issued a $50,000 face value, 8% five-year bond for $46,139 that will yield 10%. Interest is payable on June 30 and December 31. What is the bond carrying amount on December 31 of the current year?
This problem requires the calculation of the amount of bond discount amortization through the end of the current year. Journal entries are the best way to do this. The two interest payment entries are as follows. June 30 entry: dr. Interest expense $2,307 ($46,139 x .05), cr. Discount $307, cr. Cash $2,000 ($50,000 x .04). The effective interest method is required (SL method is not mentioned). The discount amortization increases the carrying value of the liability because there is less discount remaining. Dec. 31 entry: dr. Interest expense $2,322 [($46,139 + $307) x .05], cr. Discount $322, cr. Cash $2,000 ($50,000 x .04). Carrying amount is now $46,139 $307 $322 = $46,768.
What items do you identify when approaching a bond question?
1. Issue Date
2. Bond date
3. Face Value
4. Coupon or Stated Rate
5. Effective interest rate or yield rate
6. Interest payment dates
7. Maturity date
T/F: Market rate > Stated Rate = discount
T/F: Market rate
False. This = premium
The market price of a bond issued at a premium is equal to the present value of its principal amount
A. Only, at the stated interest rate.
B. In addition to the present value of all future interest payments, at the stated interest rate
C. Only, at the market (effective) interest rate
D. In addition to the present value of all future interest payments at the market (effective) interest rate
D. The market price of a bond is the present value of all remaining payments, both principal and interest, at the effective interest rate.
T/F: Bond issue costs are immediately expensed.
They are capitalized as a noncurrent deferred charge and amortized to expense over the term of the bonds using the straight-line method.
T/F: Either of the two available methods of amortizing bond discount may be used for any bond issue.
The effective interest method, and the straight line method. The SL method is acceptable only if the results do not depart materially from the effective interest method.
T/F: A secured bond and a debenture have the same security with respect to ultimate payment of principal.
A secured bond issue has a claim to specific assets. Otherwise, the bondholders are unsecured creditors and are grouped with other unsecured creditors. (An unsecured bond is backed only by the credit rating of the issuing firm)
T/F: The bond term is usually the period between bond date and maturity date.
Bond term = the period from issuance date to maturity date.
T/F: Under the straight-line method, interest expense for a period is a directly calculated value.
This method recognizes a constant amount of amortization each month of the bond term.
T/F: The period over which bond discount or premium is amortized is the period from bond issue date to maturity date, even if the firm contemplates retiring the bonds early.
T/F: The ratio of interest expense to beginning book value over the bond term is constant under the straight-line method.
This ratio is used in the effective interest method, and would never be constant as the difference between interest expense and the cash interest paid would change from period to period.
T/F: Bond issue costs are treated as a reduction of the proceeds on the bond.
Bond issue costs are not netted against the proceeds. Like accrued interest, bond issue costs have no effect on the premium or discount recorded.
These are costs that are accounted for separately.
T/F: Under either method of amortizing bond discount, total interest expense is the same over the bond term and equals total cash interest paid over the bond term plus the original discount.
The effective interest method, and the straight line method. Interest expense varies from period to period with the effective interest method, and stays constant under the SL method.
T/F: The unamortized discount balance at the end of a period equals the beginning balance less the discount amortized that period.
T/F: The carrying value of a bond issue equals face value less unamortized premium.
This would be true if it were an unamortized discount.
If the bond is a premium, you would add the unamortized premium.
T/F: The unamortized premium balance at the end of a period equals the beginning balance plus the premium amortized that period.
The unamortized premium balance at the end of a period equals the beginning balance LESS the premium amortized that period
T/F: Under the effective interest method, amortization of discount is a directly calculated value.
Under the effective interest method, the book value changes with each interest entry. Each entry recognizes a different amount of interest.
T/F: The ratio of interest expense to beginning book value of the bond over the bond term is constant under the effective interest method.
On July 1, 2005, Eagle Corp. issued 600 of its 10%, $1,000 bonds at 99 plus accrued interest. The bonds are dated April 1, 2005 and mature on April 1, 2015. Interest is payable semiannually on April 1 and October 1.
What amount did Eagle receive from the bond issuance?
The total amount received, which is called proceeds on the bond issue, is:
.99($1,000)(600) + .10(3/12)(600)($1,000) = $609,000.
The first factor is the total bond price, exclusive of accrued interest. The second factor is the accrued interest since 4/1/05.
When bonds are issued between interest dates, the cash interest since the most recent past interest payment date must be collected from the bondholders because a full six months' interest is paid on the following interest date.
A bond issued on June 1, 2005 has interest payment dates of April 1 and October 1.
The bond interest expense for the year ended December 31, 2005 is for a period of
A. Seven months.
B. Six months.
C. Four months.
D. Three months.
A. Interest expense is recognized only during the bond term, which began June 1 when the bonds were issued. The bonds were outstanding 7 months in 2005. Seven months of interest is recognized in 2005.
On October 1, 2005, Brock, Inc. issued 200 of its 10%, $1,000 bonds at 101 plus accrued interest. The bonds are dated July 1, 2005, and mature on July 1, 2015. Interest is payable semiannually on January 1 and July 1.
At the time of issuance, Brock received cash of
The proceeds on a bond issue equal the total bond price plus accrued interest since the last interest date. The proceeds of $207,000 = 200($1,000)(1.01) + 200($1,000)(.10)(3/12).
The 3/12 factor is the time between the bond date (or previous interest date) and the issuance date.
On June 30, 2005, Huff Corp. issued at 99, 1000 of its 8%, $1,000 bonds. The bonds were issued through an underwriter to whom Huff paid bond issue costs of $35,000.
On June 30, 2005, Huff should report the bond liability at
The $990,000 net bond liability equals the $1,000,000 face value less the $10,000 discount. The discount is computed as (1.00 - .99)($1,000,000) = $10,000, which is the face value less the bond price. The bond issue costs are separately reported as a deferred charge.
Another way to compute the net bond liability at issuance is to apply the unit bond price to the total face value: $990,000 = .99($1,000,000).
On January 2, 2004, Gill Co. issued $2,000,000 of 10-year, 8% bonds at par. The bonds, dated January 1, 2004, pay interest semiannually on January 1 and July 1. Bond issue costs were $250,000.
What amount of bond issue costs are unamortized at June 30, 2005?
The bond term is 10 years. At 6/30/05, 8 1/2 years remain in the bond term. Thus, $212,500 [$250,000(8.5)/10] remain unamortized.
Dixon Co. incurred costs of $3,300 when it issued, on August 31, 2005, 5-year debenture bonds dated April 1, 2005.
What amount of bond issue expense should Dixon report in its income statement for the year ended December 31, 2005?
There are four years and seven months in the bond term (5 years less the 5 months from April 1 to August 31) or a total of 55 months. Thus, the 2005 amortization of bond issue costs, which is capitalized as a deferred charge, is $240 [(4/55)$3,300]. The bonds were outstanding four months in 2005.
A bond issued on June 1, 2004 has interest payment dates of April 1 and October 1. The bond interest expense for the year ended December 31, 2004 is for a period of X months. X = ?
X = 7 months
The bonds have been outstanding seven months by the end of 2004. The firm has borrowed money for seven months. Therefore, seven months' interest should be recognized in 2004.
Only six months of interest was PAID in 2004 because the bonds were issued after April 1 (one of the two interest payment dates per year), but that is not what the question asks.
Perk, Inc. issued $500,000, 10% bonds to yield 8%. Bond issuance costs were $10,000.
How should Perk calculate the net proceeds to be received from the issuance?
A. Discount the bonds at the stated rate of interest.
B. Discount the bonds at the market rate of interest.
C. Discount the bonds at the stated rate of interest and deduct bond issuance costs.
D. Discount the bonds at the market rate of interest and deduct bond issuance costs.
D. The price at which bonds sell is calculated as the present value of the principal amount plus the present value of the bond interest payments; both are discounted using the market rate of interest appropriate for the bonds. (The market rate of interest is also the effective rate or the interest rate the bonds will yield.) The bond issue cost will be deducted from the gross proceeds to determine the net amount to be received by the issuer.
T/F: The bond price and proceeds are the same for a bond without accrued interest.
The bond price will not change, and without accrued interest, there are no proceeds to be paid on the bond.
T/F: Accrued interest on a bond issue is based on the market rate of interest.
The accrued interest computation uses the stated rate x the face value of bond.
T/F: Accrued interest on a bond is computed using the yield rate and the beginning book value.
Uses the stated/coupon rate of interest and the beginning book value.
T/F: The bond price and proceeds are the same for a bond with accrued interest.
The bond price will not change, however the proceeds will change depending on the amount of time between interest payments that make up the accrued interest to be collected.
T/F: Under international accounting standards, the fair value option cannot be chosen arbitrarily for specific bond issues.
T/F: Under international accounting standards, bond issue costs increase the discount on the bond issue.
T/F: A firm uses the effective interest method to amortize the premium on a bond issue which pays interest semiannually. Row 5 of the bond's amortization schedule has the amounts for the six-month period ending 6/30/x2. The amount for row 5 in the interest expense column equals the product of (1) one-half the coupon rate, and (2) the amount in row 4 for the bond book value column.
interest expense = Carrying value from previous period x 1/2 market value interest rate
T/F: The fair value option as it applies to reporting a bond liability must be chosen by a firm if that firm's bond issue fluctuates in value during its term.
The firm makes an irrevocable decision on the date of issuance.
T/F: The fair value option as it applies to reporting a bond liability must be applied to all bond issues for a firm.
The FVO can be applied to all or a subset of debt instruments, even within the same type.
On January 1, Stunt Corp. had outstanding convertible bonds with a face value of $1,000,000 and an unamortized discount of $100,000. On that date, the bonds were converted into 100,000 shares of $1 par stock. The market value on the date of conversion was $12 per share. The transaction will be accounted for with the book value method. By what amount will Stunt's stockholders' equity increase as a result of the bond conversion?
Under the book value method, the owners' equity of the issuing firm is increased by the book value of the debt converted. In this case, the book value is $900,000 ($1,000,000 face value less $100,000 discount). The market value of the stock issued is not used in this method. The common stock is credited for $100,000 (100,000 x $1), and additional paid in capital is increased for the $800,000 remainder. There is no gain or loss. The bond payable accounts are closed on conversion.
On July 1, 2004, after recording interest and amortization, York Co. 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, and York's common stock was publicly trading at $30 per share.
Using the book value method, what amount of additional paid-in capital should York record as a result of the conversion?
A journal entry illustrates how the answer can be derived:
dr. Bonds payable 1,000,000
dr. Premium on bonds payable 300,000
cr. Common stock 50,000($1) 50,000
cr. Additional paid-in capital 1,250,000
Under the book value method, the book value of the bonds is transferred to the common stock accounts. Market values are not used in the recording. The common stock is recorded at par with the remaining book value allocated to the additional paid-in capital.
On January 2, 2003, Chard Co. issued 10-year convertible bonds at 105. During 2006, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds. At conversion, the market price of Chard's common stock was 50 percent above its par value.
Depending on whether the book value method or the market value method was used, Chard would recognize gains or losses on conversion when using the
Book value method
Market value method
Book value method = Neither G/L
Market value method = Loss
Under the book value method, the book value of the bonds converted is transferred to the common stock account and additional paid-in capital. No gain or loss is recorded. The market value of the stock issued on conversion is not used in the recording of the stock.
Under the market value method, the stock issued is recorded at its market value. The bonds were issued at a small premium, a portion of which has been amortized. The stock issued has an aggregate par equal to the face value of the bonds.
The stock's market value is much higher than its par value. Thus, the bond carrying value is considerably less than the market value of the stock issued according to the information in the question.
Therefore, the recorded value of the common stock and additional paid-in capital of the stock issued exceeds the book value of the bonds, causing a loss to be recorded.
Which of the following is generally associated with the terms of convertible debt securities?
A. An interest rate that is lower than nonconvertible debt.
B. An initial conversion price that is less than the market value of the common stock at time of issuance.
C. A non-callable feature
D. A feature to subordinate the security to nonconvertible debt
A. Investors of convertible debt receive the security of debt (guaranteed principal and interest) plus the option of converting to stock if the value of the stock has appreciated. This conversion feature entices investors to accept a lower interest rate than would be given with a non-convertible debt issue.
On January 2, 2002, Chard Co. issued 10-year convertible bonds at 105. During 2005, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds.
At conversion, the market price of Chard's common stock was 50 percent above its par value.
On January 2, 2002, cash proceeds from the issuance of the convertible bonds should be reported as
A. Contributed capital for the entire proceeds.
B. Contributed capital for the portion of the proceeds attributable to the conversion feature and as a liability for the balance.
C. A liability for the face amount of the bonds and contributed capital for the premium over the face amount
D. A liability for the entire proceeds
D. There is no method of objectively determining the value of the conversion feature for a convertible bond. The conversion feature is not separable as is the case with detachable stock warrants.
Thus, the entire proceeds are allocated to the bond liability, which in this case includes a premium.
Which of the following statements characterizes convertible debt?
A. The holder of the debt must be repaid with shares of the issuer's stock.
B. No value is assigned to the conversion feature when convertible debt is issued.
C. The transaction should be recorded as the issuance of stock.
D. The issuer's stock price is less than market value when the debt is converted.
B. In contrast to stock issued with detachable warrants, bonds convertible to stock are recorded the same way as nonconvertible bonds. The conversion feature is not separable at the issue date; there is no known market value for the conversion feature. Therefore, no value is assigned to the conversion feature at issuance.
T/F: The allocation issue for bonds with detachable stock warrants is the same allocation issue found in convertible bonds.
No part of the bond price is allocated to the conversion feature, in direct contrast with bonds issued with detachable stock warrants.
T/F: No attempt is made to allocate the price of a convertible bond to the conversion feature.
T/F: Under the market value method, the sum of the amounts credited to capital stock and contributed capital in excess of par equals the total market value of the stock issued on conversion.
T/F: When using the market value method, the loss on conversion is recorded in owners' equity.
A G/L is recorded to the Conversion of Bonds account
On December 30, 2004, Fort, Inc. issued 1,000 of its 8%, 10-year, $1,000 face value bonds with detachable stock warrants at par.
Each bond carried a detachable warrant for one share of Fort's common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1,080,000, and the market value of the warrants was $120,000.
In its December 31, 2004, balance sheet, what amount should Fort report as bonds payable?
The proceeds of the issue ($1,000,000 because the bonds were issued at par) is allocated based on the relative fair values of the two securities. The total market value of the two securities after issuance is $1,200,000 ($1,080,000 + $120,000). The allocation to the bonds is then $900,000 [($1,080,000/$1,200,000)$1,000,000].
On March 1, 20x2, Evan Corp. issued $500,000 in 10% nonconvertible bonds at 103, due on February 28, 2009. Each $1,000 bond was issued with 30 detachable stock warrants, each of which entitled the holder to purchase, for $50, one share of Evan's $25 par common stock. On March 1, 20x2, the market price of each warrant was $4. By what amount should the bond issue proceeds increase stockholders' equity?
Only the warrants have a known market value. Therefore, that value is allocated to the warrants.
Had both the warrants and bonds (without warrants) been quoted, then the issue proceeds would be allocated based on relative sales value.
The total market value of the warrants is $60,000 = 500 bonds x 30 warrants per bond x $4 market value per warrant.
Quoit, Inc. issued preferred stock with detachable common stock warrants. The issue price exceeded the sum of the warrants' fair value and the preferred stocks' par value. The preferred stocks' fair value was not determinable.
What amount should be assigned to the warrants outstanding?
A. Total proceeds.
B. Excess of proceeds over the par value of the preferred stock
C. The proportion of the proceeds that the warrants' fair value bears to the preferred stocks' par value
D. The fair value of the warrants
D. When the market value for only one of the two securities is known, the known market value is allocated to that security, and the proceeds less this market value is allocated to the other security.
In this case, the market value of the warrants is known, but the market value of the preferred is not. Therefore, the preferred stock is recorded at the total amount of the proceeds from the entire issue, less the total market value of the warrants.
Had the market value of both securities been known, then the total proceeds would have been allocated based on the relative fair values of the securities.
Blue Co. issued preferred stock with detachable common stock warrants at a price which exceeded both the par value and the market value of the preferred stock.
At the time the warrants are exercised, Blue's total stockholders' equity is increased by the
Cash received upon exercise of the warrants
Carrying amount of warrant
Cash received upon exercise of the warrants = Yes
Carrying amount of warrant = No
When the preferred stock was issued, a portion of the proceeds was allocated to an owners' equity account for the warrants. When the warrants are exercised, this account, which holds the carrying value of the warrants, is closed.
Cash is increased, and common stock (and possibly contributed capital in excess of par) also is increased to account for the issuance of stock. The net effect on owners' equity of the exercise is, therefore, the amount of cash received.
Y/N: Are both of the following statements correct?
1. When the market values of both the bonds and detachable stock warrants are known, the allocation of total bond price is based on relative market values.
2. When only one of the market values is known, that market value is the allocation to the relevant security, and the allocation to the other security is the remaining amount of the price to allocate.
T/F: The market value of only the bonds sold with detachable stock warrants is known. The market value of the warrants cannot be ascertained. Therefore, the bond price is allocated based on the relative market values.
If the FMV of only one security is known, proceeds equal to the FMV are allocated to that security, and the incremental proceeds are allocated tot he remaining security.
T/F: The proceeds of a bond issue with detachable warrants, including accrued interest, is allocated to the bonds and warrants based on relative market value if both market values are known.
If the FMV of bonds and stock warrants can be determined, the proceeds are allocated based on the respective FMV of the securities. Accrued interest is not included.
T/F: If bonds sold with detachable stock warrants sell for 104, then the bonds must be recorded at a premium.
Not necessarily. After allocating a portion of the proceeds to the warrants, an amount less than face value may be allocated to the bonds resulting in a discount.
T/F: The allocation of the bond price to detachable stock warrants is recorded in an owners' equity account.