Notes and Bonds payable

Question 1

On January 1, year 7, Dean Company issued ten-year bonds with a face value of $1,000,000 and a stated interest rate of 8% per year payable semiannually on July 1 and January 1. The bonds were sold to yield 10%. Present value factors are as follows:

Present value of $1 for 10 periods at 10% .386
Present value of $1 for 20 periods at 5% .377
Present value of an annuity of 1 for 10 periods at 10% 6.145
Present value of an annuity of 1 for 20 periods at 5% 12.462
What is the total amount of Dean Company’s term bonds?

Answer 1

$875,480

Present Value of the Interest Annuity

Interest Payment = $1,000,000 × 8% × 6/12 = $40,000
PV of Interest Annuity=$40,000 × 12.462 = $498,480
Here, the factor 12.462 is the present value of an annuity of $1 for 20 periods at 5% (since interest is compounded semi-annually).

Present Value of the Principal (Face Value)

PV of Principal = $1,000,000 × 0.377 = $377,000
Here, the factor 0.377 is the present value of $1 for 20 periods at 5% (since interest is compounded semi-annually).

Total Present Value of the Bonds

Total PV = PV of Interest Annuity + PV of Principal
Total PV = $498,480 + $377,000 = $875,480

Question 2

Which of the following is true regarding debt issued with detachable stock warrants?

• Proceeds must be allocated between the warrants and the debt security based on relative fair values.
• If the fair value (FV) of one security is not determinable, the proceeds are assigned based on the book value of the other security.
• The warrants are accounted for as an expense.
• All of the above

Answer 2

Proceeds must be allocated between the warrants and the debt security based on relative fair values.

Question 3

A company issues $2,000,000 of par bonds at 97 on January 1, year 1, with a maturity date of December 31, year 30. Bond issue costs are $120,000, and the stated interest rate of the bonds is 8%. Interest is paid semiannually on January 1 and July 1. Ten years after the issue date, the entire issue was called at 103 and canceled. The company uses the straight-line method of amortization for bond discounts and issue costs, and the result of this method is not materially different from the effective interest method. The company should classify what amount as the loss on extinguishment of debt at the time the bonds are called?

Answer 3

$180,000

Bond Payable (Face Value) $2,000,000
Unamortized Discount [($60,000 / 30) × 20 yrs.] ($40,000)
Unamortized Issue costs [($120,000 / 30) × 20 yrs.] ($80,000)
Carrying amount of bonds retired $1,880,000
Purchase price ($2,000,000 × 103%) $2,060,000
Loss on bond retirement, before income taxes ($180,000)