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Flashcards in Present Value Bonds (Bond Accounting) Deck (81):
1

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

  1. Less the present value of all future interest payments at the market (effective) rate of interest.
  2. This is less the present value of all future interest payments at the rate of interest stated on the bond
  3. Plus the present value of all future interest payments at the market (effective) rate of interest
  4. Plus the present value of all future interest payments at the rate of interest stated on the bond

Plus the present value of all future interest payments at the market (effective) rate of interest

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.

2

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?

  1. 6%
  2. 7%
  3. 12%
  4. 14%

12%

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.

3

On January 1 of the current year, Lean Co. made an investment of $10,000. The following is the present value of $1.00 discounted at a 10% interest rate:

Present value of $1.00

Periods / Discounted at 10%

  • 1 / .909
  • 2 / .826
  • 3 / .751

What amount of cash will Lean accumulate in two years?

  1. $12,000
  2. $12,107
  3. $16,250
  4. $27,002

$12,107

The future value of $1 is the reciprocal of the present value of $1. The $10,000 invested therefore will accumulate to $10,000(1/.826) = $12,107 in two years.

Another calculation leading to the same result is $10,000(1.10)(1.10) = $12,100 (discrepancy due to rounding of the present value factor).

4

On September 30, World Co. borrowed $1,000,000 on a 9% note payable. World paid the first of four quarterly payments of $264,200 when due on December 30.

In its income statement for the year, what amount should World report as interest expense?

  1. $0
  2. $14,200
  3. $22,500
  4. $30,000

$22,500

The interest for three months on $1 million at 9% is $22,500: .09 x 3/12 x $1,000,000 = $22,500. This amount is part of the first payment; principal reduction of $241,700 is the other part.

No principal payment was made before the first payment, which occurred at year-end. There was no reduction in principal before the first payment.

5

When debt is issued at a discount, interest expense over the term of debt equals the cash interest paid

  1. Minus discount
  2. Minus discount minus par value
  3. Plus discount
  4. Plus discount plus par value

Plus discount

When debt is issued at a discount from face value, the firm receives an amount less than face value but must pay the face value at issuance.

Interest is defined as amounts paid to service debt over and above the amount borrowed. For example, a $1,000 face value bond issued for $940 creates a $60 discount. The firm must pay the cash interest required over the bond term and $1,000 face value at the end of the term.

The $60 discount represents an additional amount that must be paid in excess of the amount borrowed ($940).

6

Hancock Co.'s December 31, 2005 balance sheet contained the following items in the long-term liabilities section:

Unsecured

  • 9.375% registered bonds ($25,000 maturing annually beginning in 2009) $275,000
  • 11.5% convertible bonds, callable beginning in 2014, due 2025 $125,000

Secured

  • 9.875% guaranty security bonds, due 2025 $250,000
  • 10.0% commodity backed bonds ($50,000 maturing annually beginning in 2010) $200,000

What are the total amounts of serial bonds and debenture bonds?

  • Serial bonds
  • Debenture bonds  

  • Serial bonds - $475,000
  • Debenture bonds - $400,000

Serial bonds mature at regular intervals rather than on one single date. Debenture bonds are not secured but rather are backed only by the general credit of the issuing firm. Debenture bonds can be serial bonds. Therefore, the total amount of debenture bonds equals the total of the unsecured bond issues or $400,000 ($275,000 + $125,000).

There are two serial bonds: the 9.375% unsecured bonds ($275,000) and the 10% secured bonds ($200,000), for a total of $475,000.

7

On January 1, 2005, Korn Co. sold to Kay Corp. $400,000 of its 10% bonds for $354,118 to yield 12%. Interest is payable semiannually on January 1 and July 1.

What amount should Korn report as interest expense for the six months ended June 30, 2005?

  1. $17,706
  2. $20,000
  3. $21,247
  4. $24,000

$21,247

Interest expense = $354,118(.12/2) = $21,247

The yield rate is applied to the beginning book value of the bonds. The interest expense is for 1/2 a year. This requires that 1/2 of the yield rate be applied. The beginning book value is used because that is the debt 6 months before the interest is recognized.

Interest is defined as the true yield rate multiplied by the debt balance at the beginning of the interest period.

8

What type of bonds mature in installments?

  1. Debenture.
  2. Term.
  3. Variable rate.
  4. Serial.

Serial.

Serial bonds mature serially according to a schedule set in the bond contract. At each date, a portion of the bond issue is paid off (matures) until the entire face value of the issue is retired. Each portion is a percentage of the total face value of the issue. Serial bonds are designed to reduce the risk, to the bondholder, of default by the issuing firm.

9

On January 2, Vole Co. issued bonds with a face value of $480,000 at a discount to yield 10%. The bonds pay interest semiannually. On June 30, Vole paid bond interest of $14,400. After Vole recorded amortization of the bond discount of $3,600, the bonds had a carrying amount of $363,600. What amount did Vole receive upon issuing the bonds?

  1. $360,000
  2. $367,200
  3. $476,400
  4. $480,000

$360,000

The carrying value of the bonds after the first interest payment is $363,600 which reflects $3,600 of discount amortization. Because discount amortization increases the carrying value of the bond by reducing the discount, the carrying value (and amount received at issuance) must have been $3,600 less or $360,000 ($363,600 - $3,600). As discount is amortized, the carrying value gradually increases to the maturity (face) value over the bond term.

10

What type of bonds in a particular bond issuance will not all mature on the same date?

  1. Debenture bonds.
  2. Serial bonds
  3. Term bonds
  4. Sinking fund bonds

Serial bonds

Serial bonds mature according to a schedule. For example, after 20 years, 10% of the bonds may be retired at the end of each of the next 10 years. The bond term ends at the end of the 30th year.

11

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?

  1. $46,139
  2. $46,446
  3. $46,768
  4. $47,106

$46,768

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.

12

On January 1, 2004, Oak Co. issued 400 of its 8%, $1,000 bonds at 97 plus accrued interest.

The bonds are dated October 1, 2003 and mature on October 1, 2013. Interest is payable semiannually on April 1 and October 1. Accrued interest for the period October 1, 2003 to January 1, 2004, amounted to $8,000.

On January 1, 2004, what amount should Oak report as bonds payable, net of discount?

  1. $380,300
  2. $388,000
  3. $388,300
  4. $392,000

$388,000

The net book value of the bonds on the issuance date is $388,000 (.97 x $400,000). The three months of accrued interest collected on issuance increases the proceeds but does not affect the net bond liability. Accrued interest is reported separately from the net bond liability.

13

Webb Co. has outstanding a 7%, 10-year $100,000 face-value bond.

The bond was originally sold to yield 6% annual interest. Webb uses the effective interest rate method to amortize bond premium. On June 30, 2004, the carrying amount of the outstanding bond was $105,000.

What amount of unamortized premium on bond should Webb report in its June 30, 2005 balance sheet?

  1. $1,050
  2. $3,950
  3. $4,300
  4. $4,500

$4,300

The bond premium at 6/30/04 is $5,000, the difference between the bond carrying value and the bond face value.

This question requires you to compute amortization of bond premium for the year 7/1/04 - 6/30/05. The amortization is then subtracted from the $5,000 to determine the unamortized premium balance at 6/30/05. Under the effective interest method, interest expense is directly determined. The amortization of the premium reduces interest expense relative to cash interest paid because each payment is partly a return of principal.

The following equation may be used to determine the amortization for this annual period:

Amortization of bond premium + Interest expense = cash interest paid X + 06($105,000) = .07($100,000) X + $6,300 = $7,000 X = $700 

14

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

  1. Face value of the bonds at the beginning of the period by the contractual interest rate.
  2. This is the face value of the bonds at the beginning of the period by the effective interest rate.
  3. Carrying value of the bonds at the beginning of the period by the contractual interest rate
  4. Carrying value of the bonds at the beginning of the period by the effective interest rate

Face value of the bonds at the beginning of the period by the contractual interest rate.

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.

15

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?

  1. Price.
  2. Par.
  3. Yield.
  4. Interest.

Price.

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.

16

A company issues bonds at 98, with a maturity value of $50,000. The entry the company uses to record the original issue should include which of the following?

  1. A debit to bond discount of $1,000.
  2. A credit to bonds payable of $49,000
  3. A credit to bond premium of $1,000
  4. A debit to bonds payable of $50,000

A debit to bond discount of $1,000.

The price of 98 refers to 98% of the face value or $49,000 ($50,000 x .98). The issuance entry is: dr. Cash $49,000, dr. Discount, $1,000, cr. Bonds Payable $50,000. The discount is a contra bonds payable account.

17

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?

  1. $62,000
  2. $60,100
  3. $58,900
  4. $58,590

$60,100

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

  • Interest expense ($1,000,000 + $62,000)(.10)(1/2) $53,100
  • Bond premium $1,900
  • Interest payable ($1,000,000)(.11)(1/2) $55,000

18

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?

  1. An interest expense that is less than the cash payment made to bondholders.
  2. An interest expense that is greater than the cash payment made to bondholders.
  3. A debit to the unamortized bond discount
  4. A debit to the unamortized bond premium

An interest expense that is greater than the cash payment made to bondholders.

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.

19

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

  1. $207,000
  2. $205,000
  3. $202,000
  4. $197,000

$207,000

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.

20

On December 31, 2005. Cobb issued 2,000 of its 10%, $1,000 bonds at 99. The issuance price established a bond discount of $20,000. In connection with the sale of these bonds. Cobb paid the following expenses:

  • Legal and accounting fees $45,000
  • Printing of the prospectus $55,000
  • Underwriting fees $85,000

In Cobb's December 31, 2005 balance sheet, bond issue costs should be reported as

A.  $120,000

B.  $130,000

C.  $160,000

D.  $185,000

$185,000

Legal and accounting fees $ 45,000

Printing of the prospectus $55,000

Underwriting fees $85,000

Total bond issue costs $$185,000

21

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?

  1. $579,000
  2. $594,000
  3. $600,000
  4. $609,000

$609,000

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.

22

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

  1. Three months.
  2. Four months
  3. Six months
  4. Seven months

Seven 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.

23

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

  1. $955,000
  2. $990,000
  3. $1,000,000
  4. $1,025,000

$955,000

The net carrying value equals total face value less the discount less the bond issue costs. The discount is implied in the "99" price which is stated as a percent of face value: $955,000 = (.99 price)(1000 bonds)($1,000 face value) − $35,000.

24

On March 1, 2005, Cain Corp. issued at 103 plus accrued interest, 200 of its 9%, $1,000 bonds. 
The bonds are dated January 1, 2005 and mature on January 1, 2015. Interest is payable semi-annually on January 1 and July 1. 

Cain paid bond issue costs of $10,000.

Cain should realize net cash receipts from the bond issuance of

  1. $216,000
  2. $209,000
  3. $206,000
  4. $199,000

$199,000

The net cash receipts from the bond issue equals the total bond price plus accrued interest between the bond date and the issue date less the bond issue costs. Accrued interest is collected from the bondholders for two months because they will be paid six months of interest on July 1.

They will have held the bonds only for four months and therefore should only earn four months of interest. The bonds must pay six month's interest on each interest date. That is why the bondholders must pay two month's interest when they purchase the bonds.

$199,000 = net cash realized = total bond price + accrued interest - bond issue costs

= 1.03(200)($1,000) + .09(200)($1,000)(2/12) - $10,000

25

On July 1, 2005, Howe Corp. issued 300 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 semi-annually on April 1 and October 1.

What amount did Howe receive from the bond issuance?

  1. $304,500
  2. $300,000
  3. $297,000
  4. $289,500

$304,500

The amount received is the price of the bonds plus interest from April 1, the bond date, to July 1, the issue date:

Amount received = .99(300)($1,000) + .10(3/12 year)(300)($1,000) = $304,500

The second term in the above calculation uses 3/12 of a year, which is the portion of a year between April 1 and July 1.

26

During 2002, Lake Co. issued 3,000 of its 9%, $1,000 face value bonds at 101 1/2. In connection with the sale of these bonds, Lake paid the following expenses:

  • Promotion costs $20,000
  • Engraving and printing $25,000
  • Underwriters' commissions $200,000

What amount should Lake record as bond issue costs to be amortized over the term of the bonds?

  1. $0
  2. $220,000
  3. $225,000
  4. $245,000

$245,000

All three listed costs are included in bond issue costs and are amortized over the term of the bonds. All three contribute to the effort of issuing the bonds.

27

On September 1, 2005, Cobb Co. issued a note payable to the National Bank in the amount of $900,000, bearing interest at 12%, and payable in three equal annual principal payments of $300,000. 
On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2006.

At December 31, 2006, Cobb should record accrued interest payable of

  1. $36,000
  2. $33,000
  3. $24,000
  4. $22,000

$24,000

As of 12/31/06, the first $300,000 principal installment has been paid, along with interest. This payment was made 9/1/06. The remaining principal outstanding on that date is $600,000 ($900,000 - $300,000). Thus, accrued interest on 12/31/06 is $24,000 = 600,000(.12)(4/12).

28

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?

  1. $220
  2. $240
  3. $495
  4. $3,300

$240

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.

29

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 gain nor loss 
  • 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.

30

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

  1. Contributed capital for the entire proceeds.
  2. Contributed capital for the portion of the proceeds attributable to the conversion feature and as a liability for the balance.
  3. A liability for the face amount of the bonds and contributed capital for the premium over the face amount
  4. A liability for the entire proceeds

A liability for the entire proceeds

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.

31

Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record?

  1. $302,000
  2. $325,000
  3. $348,000
  4. $798,000

$302,000

Without fair value information, the book value method of allocating the bond carrying value to the owners' equity accounts must be used. The carrying value of the bond issue is $752,000 ($775,000 - $23,000). Of that amount, $450,000 is first allocated to the common stock account at par value (90,000 shares issued x $5). The remainder, or $302,000 ($752,000 - $450,000) is allocated to additional paid in capital.

32

On March 31, 2004, Ashley, Inc.'s bondholders exchanged their convertible bonds for common stock. The carrying amount of these bonds on Ashley's books was less than the market value but greater than the par value of the common stock issued.

If Ashley used the book value method of accounting for the conversion, which of the following statements is correct for an effect of this conversion?

  1. Stockholders' equity is increased.
  2. Additional paid-in capital is decreased.
  3. Retained earnings is increased.
  4. A loss is recognized.

Stockholders' equity is increased.

When bonds are converted to stock and accounted for by the book value method, the owners' equity is increased by the book value of the bonds.

There is no gain or loss because the book value of the bonds is simply transferred to the stock accounts. Common stock, and additional paid in capital are increased if necessary. If the total par of common stock issued exceeds the book value of the bonds, then retained earnings is decreased. Retained earnings can never be increased on conversion.

33

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?

  1. $950,000
  2. $1,250,000
  3. $1,350,000
  4. $1,500,000

$1,250,000

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

34

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?

  1. $579,000
  2. $594,000
  3. $600,000
  4. $609,000

$609,000

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.

35

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?

  1. Total proceeds.
  2. Excess of proceeds over the par value of the preferred stock
  3. The proportion of the proceeds that the warrants' fair value bears to the preferred stocks' par value
  4. The fair value of the warrants

The fair value of the warrants

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.

36

Ray Corp. issued bonds with a face amount of $200,000. Each $1,000 bond contained detachable stock warrants for 100 shares of Ray's common stock. 
Total proceeds from the issue amounted to $240,000. 
The market value of each warrant was $2, and the market value of the bonds without the warrants was $196,000.

The bonds were issued at a discount of

  1. $0
  2. $678
  3. $4,000
  4. $33,898

$678

The proceeds are allocated based on relative market values:

Market value of bonds:

  • $196,000 
  • +  market value of warrants: (200 bonds)(100 warrants/bond)($2) = $40,000
  • = total market value of the securities $236,000

37

For a bond issue which sells for less than its par value, the market rate of interest is

  1. Dependent on rate stated on the bond.
  2. Equal to rate stated on the bond.
  3. Less than rate stated on the bond.
  4. Higher than rate stated on the bond.

Higher than rate stated on the bond.

Bonds generally provide for periodic fixed interest payments at a stated rate of interest. At issuance, the market (yield) rate of interest for the particular bond may be above, the same as, or below the stated rate. When the market (yield) rate of interest is higher than the stated rate, the bond will sell for less than its par value (as in this case). By selling the bond for less, the effective interest rate will equal the market (yield) rate.

38

The proceeds from a bond issued with detachable stock purchase warrants should be accounted for

  1. Entirely as bonds payable.
  2. Entirely as stockholders’ equity.
  3. Partially as unearned revenue, and partially as bonds payable.
  4. Partially as stockholders’ equity, and partially as bonds payable.

Partially as stockholders’ equity, and partially as bonds payable.

Bonds issued with stock purchase warrants are, in substance, composed of two elements, a debt element and a stockholders’ equity element. Per ASC Topic 470, proceeds from bonds issued with detachable stock purchase warrants should be allocated between the bonds and the warrants on the basis of their relative fair market values. Detachable warrants are traded separately from the debt and have an available fair market value. The amount allocated to the warrants should be accounted for as stockholders’ equity with the remainder allocated to bonds payable.

39

On June 1 of the current year, Cross Corp. issued $300,000 of 8% bonds payable at par with interest payment dates of April 1 and October 1. In its income statement for the current year ended December 31, what amount of interest expense should Cross report?

  1. $6,000
  2. $8,000
  3. $12,000
  4. $14,000

$14,000

Seven months of interest should be accrued, or $14,000 = ($300,000 × 8% × 7/12).

40

Colfax issued bonds with detachable common stock warrants. Only the warrants had a known market value. The sum of the fair value of the warrants and the face amount of the bonds was less than the cash proceeds. How should the warrants be recorded?

  1. Record the warrants at fair value of the warrants.
  2. Record the warrants when they are exercised.
  3. Record the warrants for the difference between cash proceeds and face value of the bonds.
  4. Record the warrants at the par value of the common stock.

Record the warrants at fair value of the warrants.

ASC Topic 470 states that the proceeds from the issuance of debt with detachable stock warrants should be allocated between the debt and equity components. This is usually done by allocating the proceeds based on the relative fair market value of each security. However, in a case where only the value of the warrants is known, the warrants are recorded at their fair market value, and the remaining difference between proceeds and the value of the warrants is allocated to the bonds.

41

How would the amortization of premium on bonds payable affect each of the following?

  • Carrying value of bond
  • Net income

  • Carrying value of bond - Decrease
  • Net income - Increase

When the premium on bonds payable is amortized, the following entry is made:

  • Premium on bonds payable xxx
    • Interest expense xxx

This entry has several effects. First, it reduces the amount of the premium. Because the carrying value of the bonds is the face value of the bonds plus the unamortized premium, amortization of the premium serves to reduce the carrying value. Second, amortization of the premium decreases interest expense, thus increasing net income.

42

On March 1, year 1, Harbour Corporation issued 10% debentures dated January 1, year 1, in the face amount of $1,000,000, with interest payable on January 1 and July 1. The debentures were sold at par and accrued interest. How much should Harbour debit to cash on March 1, year 1?

  1. $966,667
  2. $983,333
  3. $1,016,667
  4. $1,033,333

$1,016,667

The amount of cash received is equal to the selling price of the bond plus accrued interest if the bond is issued between interest dates.

  • Sales price (bonds were sold at par) $1,000,000
  • Accrued interest for 2 months ($1,000,000 × 10% × 2/12) $16,667
  • $1,016,667

43

On January 1, year 1, Carr Company purchased Fay Corp. 9% bonds with a face amount of $400,000 for $375,600, to yield 10%. The bonds are dated January 1, year 1, mature on December 31, year 10, and pay interest annually on December 31. Carr uses the interest method of amortizing bond discount. In its income statement for the year ended December 31, year 1, what total amount should Carr report as interest revenue from the long-term bond investment?

  1. $40,000
  2. $37,560
  3. $36,000
  4. $34,440

$37,560

Interest revenue from a long-term investment in bonds is equal to the stated interest, adjusted for discount or premium amortization.  Carr Company uses the interest method of amortizing bond discount.  

  • Cash ($400,000 × 9%) $36,000 
  • Inv. in bonds $1,560 
    • Int. revenue $37,560

44

On March 1, year 1, Cain Corp. issued at 103 plus accrued interest 200 of its 9%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. Cain paid bond issue costs of $10,000. Cain should realize net cash receipts from the bond issuance of

  1. $216,000
  2. $209,000
  3. $206,000
  4. $199,000

$199,000

To determine the net cash received from the bond issuance, the solutions approach is to prepare the journal entry for the issuance.

  • Cash? 
  • Bond issue costs 10,000 
    •  Premium on bonds payable 6,000
    •  Bonds payable 200,000
    •  Interest expense 3,000

The bonds were issued at 103 ($200,000 × 1.03 = $206,000), so the premium is $6,000 ($206,000 – $200,000). The accrued interest covers the 2 months from 1/1 to 3/1 ($200,000 × 9% × 2/12 = $3,000).  The net cash received includes the $206,000 for the bonds and the $3,000 for the accrued interest, less the $10,000 paid for bond issue costs ($206,000 + $3,000 – $10,000 = $199,000).

45

On December 31, year 1, Wall Corp. issued $100,000 maturity value, 10% bonds for $100,000 cash. The bonds are dated December 31, year 1, and mature on December 31, year 11. Interest will be paid semiannually on June 30 and December 31. In Wall’s September 30, year 2 balance sheet, the amount of accrued interest expense should be

  1. $2,500
  2. $5,000
  3. $7,500
  4. $10,000

$2,500

The bonds payable ($100,000) pay interest semiannually on June 30 and December 31. At 9/30/Y2 the last interest date was 6/30/Y2 (3 months earlier). Therefore, Wall should report 3 months accrued interest, or $2,500 ($100,000 × 10% × 3/12 = $2,500) in its 9/30/Y2 balance sheet.

46

Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record?

  1. $302,000
  2. $325,000
  3. $348,000
  4. $798,000

$302,000

  • Bonds 775,000
    • Discount 23,000
    • Common stock (90,000 × $5) 450,000
    • Paid-in capital (plug) 302,000

47

The proceeds from a bond issued with detachable stock purchase warrants should be accounted for

  1. Entirely as bonds payable.
  2. Entirely as stockholders’ equity.
  3. Partially as unearned revenue, and partially as bonds payable.
  4. Partially as stockholders’ equity, and partially as bonds payable.

Partially as stockholders’ equity, and partially as bonds payable.

Bonds issued with stock purchase warrants are, in substance, composed of two elements, a debt element and a stockholders’ equity element. Per ASC Topic 470, proceeds from bonds issued with detachable stock purchase warrants should be allocated between the bonds and the warrants on the basis of their relative fair market values. Detachable warrants are traded separately from the debt and have an available fair market value. The amount allocated to the warrants should be accounted for as stockholders’ equity with the remainder allocated to bonds payable.

48

On July 1, year 1, Bosworth Corporation’s bondholders exchanged their convertible bonds for $1 par value common stock. The carrying value of the bonds was $50 less than the market value of the common stock issued. Bosworth uses the book value method of accounting for the conversion. Which of the following statements is true regarding the conversion of Bosworth bonds?

  1. An extraordinary loss is recognized.
  2. Additional paid-in capital is decreased.
  3. Stockholders’ equity is increased.
  4. Retained earnings is increased.

Stockholders’ equity is increased.

Stockholders’ equity is increased. Under the book value method, the common stock is recorded at the book value of the bonds at the date of conversion. Thus, no gain or loss is recognized on the conversion. The entry for conversion is to debit Bonds Payable and credit common stock and additional paid-in capital, which increases stockholders’ equity. The amount of paid-in capital is the difference between the book value of the bonds and the par value of the stock. The conversion has no effect on retained earnings. No gain or loss is recognized.

49

Wolf Company issued 1,000 of its $1,000 face amount, 20-year bonds on June 30, year 1, for $1,020,000. Each bond carries five detachable stock purchase warrants, each of which entitles the holder to purchase for $60 one share of Wolf’s common stock. On June 30, year 1, the market prices were $50 per share of Wolf’s common stock and $5 per warrant. Wolf does not elect the fair value option to report its financial liabilities. In its June 30, year 1 balance sheet, at what amount should Wolf report the carrying amount of the bonds?

  1. $995,000
  2. $1,000,000
  3. $1,020,000
  4. $1,045,000

$995,000

ASC Topic 470 states that the proceeds from the sale of debt with detachable stock warrants should be allocated between the separate debt and equity elements. 1,000 bonds were issued with 5 warrants each, for a total of 5,000 warrants. APIC-Stock warrants is credited for the FV of the warrants issued or $25,000 (5,000 × $5). The remaining $995,000 ($1,020,000 − $25,000) becomes the carrying value of the bonds payable. Note that if a FV is available for the bonds without the warrants, ASC Topic 470 states that the proceeds should be allocated to the bonds and the warrants based on the relative FVs at the time of issuance.

50

On January 1, year 1, Weaver Company purchased as a long-term investment $500,000 face value of Park Corporation’s 8% bonds for $456,200. The bonds were purchased to yield 10% interest. The bonds mature on January 1, year 7, and pay interest annually on January 1. Weaver intends to hold the bonds until their scheduled maturity. Weaver uses the interest method of amortization and does not elect the fair value option for reporting financial assets. What amount should Weaver report on its December 31, year 1 balance sheet as long-term investment?

  1. $450,580
  2. $456,200
  3. $461,820
  4. $466,200

$461,820

 

Held-to-maturity investments should be reported at amortized cost on the balance sheet.  The carrying value of long-term investments on December 31, year 1, will be the carrying value on January 1, year 1, plus the discount amortization.  Discount amortization is the difference between interest revenue and interest receivable.  Interest revenue is the book value of the bonds times the yield rate of interest ($456,200 × .10 = $45,620). Interest receivable is the face value of the bonds times the face rate of interest ($500,000 × .08 = $40,000). The adjusting entry on December 31, year 1, will be

  • Interest receivable $40,000 
  • Bond investment (long-term) $5,620 
    • Interest revenue $45,620

51

On January 1, year 1, Hansen, Inc. issued for $939,000, 1,000 of its 9%, $1,000 bonds. The bonds were issued to yield 10%. The bonds are dated January 1, year 1, and mature on December 31, year 10. Interest is payable annually on December 31. Hansen uses the interest method of amortizing bond discount. In its December 31, year 1 balance sheet, Hansen should report unamortized bond discount of

  1. $57,100
  2. $54,900
  3. $51,610
  4. $51,000

$57,100

The solutions approach is to prepare the 12/31/Y1 interest entry.

  • Interest expense93,900 
    • Cash 90,000
    • Discount on bonds payable 3,900

Using the interest method, interest expense is the book (carrying) value of the bonds outstanding during the year ($939,000) times the yield rate of 10%.  The cash interest paid was the face amount of the bonds ($1,000,000) times the stated rate of 9%. The difference of $3,900 is the bond discount amortization.  Since the original discount was $61,000 ($1,000,000 less $939,000), the unamortized discount at 12/31/Y1 is $57,100 ($61,000 less $3,900).

52

On January 1, year 2, Battle Corporation sold at 97 plus accrued interest 200 of its 8%, $1,000 bonds. The bonds are dated October 1, year 1, and mature on October 1, year 12. Interest is payable semiannually on April 1 and October 1. Accrued interest for the period October 1, year 1, to January 1, year 2 amounted to $4,000. As a result on January 1, year 2, Battle would record bonds payable, net of discount, at

  1. $190,000
  2. $194,000
  3. $196,000
  4. $198,000

$194,000

Bonds payable sold at a discount should be recorded net of this discount. Battle would record the sale of these bonds at $194,000 (200 × $1,000 × .97). Note that this amount is not affected by accrued interest, which is reported separately as a current liability, interest payable.

53

Outstanding bonds payable are converted into common stock. Under either the book value or market value method, the same amount would be debited to

  • Bonds payable
  • Premium bonds payable

  • Bonds payable - YES
  • Premium bonds payable - YES

Under both the book value and market value methods of accounting for bond conversions, the bonds payable and any related premium or discount must be removed from the accounting records. The choice between the two methods, however, does not affect the removal of the bonds payable balance or the premium balance from the accounts.

54

Which of the following statements characterizes convertible debt?

  1. The holder of the debt must be repaid with shares of the issuer’s stock.
  2. No value is assigned to the conversion feature when convertible debt is issued.
  3. The transaction should be recorded as the issuance of stock.
  4. The issuer’s stock price is less than market value when the debt is converted.

No value is assigned to the conversion feature when convertible debt is issued.

ASC Topic 470 provides that when convertible debt is issued, no value is assigned to the conversion feature.

Bonds are frequently issued with the right to convert the bonds into common stock. When issued, no value is apportioned to the conversion feature.  Two approaches are possible to account for bond conversions:  valuing the transaction at cost (book value of the bonds), or valuing at market (of the stocks or bonds, whichever is more reliable).

55

An investor purchased a bond classified as a long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond is more than the

  • Cash paid to seller
  • Face amount of bond

  • Cash paid to seller - NO
  • Face amount of bond - NO

When a bond is purchased between interest dates at a discount, the amount of cash paid to the seller or issuer is equal to the face amount of the bond, plus interest accrued since the last interest payment date, less the amount of the discount. The following entry would be made on the books of the purchaser:

  • Investment in bonds (net) xxx
  • Accrued interest xxx
    • Cash xxx

On the purchase date, the carrying value of the bonds is less than both the cash paid and the face value of the bonds.

56

On July 1, year 1, Belmont Corporation issued for $960,000, 1,000 of its 9%, $1,000 callable bonds. The bonds are dated July 1, year 1, and mature on July 1, year 11. Interest is payable semiannually on January 1 and July 1. Belmont uses the straight-line method of amortizing bond discount. The bonds can be called by the issuer at 101 at any time after June 30, year 6. On July 1, year 7, Belmont called in all of the bonds and retired them. How much loss should Belmont report on this early extinguishment of debt for the year ended December 31, year 7?

  1. $50,000
  2. $34,000
  3. $26,000
  4. $10,000

$26,000

The loss on early extinguishment of debt is the difference between cash paid and the carrying amount. The bonds payable ($1,000,000) were issued at a discount of $40,000 on 7/1/Y1. The bonds are called at 101 6 years later on 7/1/Y7. Since the bonds were due in 10 years, 6/10 of the discount (6/10 × $40,000, or $24,000) would have been amortized by 7/1/Y7. Therefore, the balance in the bond discount account is $16,000 ($40,000 − $24,000), and the carrying amount of the debt is $984,000 ($1,000,000 − $16,000). The loss on the retirement is the difference between the $1,010,000 cash paid ($1,000,000 × 1.01) and the $984,000 carrying amount, or $26,000.

57

On January 2, Vole Co. issued bonds with a face value of $480,000 at a discount to yield 10%. The bonds pay interest semiannually. On June 30, Vole paid bond interest of $14,400. After Vole recorded amortization of the bond discount of $3,600, the bonds had a carrying amount of $363,600. What amount did Vole receive upon issuing the bonds?

  1. $360,000
  2. $367,200
  3. $476,400
  4. $480,000

$360,000

The issuance value is equal to carrying value at the end of year 1 less the discount amortization ($363,600 − $3,600 = $360,000).

58

When the interest payment dates of a bond are May 1 and November 1, and the bond is issued on June 1, year 1, the amount of interest expense for the year ended December 31, year 1, would be for

  1. 2 months.
  2. 6 months.
  3. 7 months.
  4. 8 months.

7 months.

The amount of the interest expense would be determined by using the time period from the date of the issuance of the bonds to the end of the year. The calculation of interest expense is not dependent on interest payment dates but rather on the length of time the bonds are outstanding. This answer is correct because interest expense would be incurred for the period from June 1, year 1, to December 31, year 1, or seven months.

59

An investor purchased a bond classified as a long-term investment between interest dates at a premium.  At the purchase date, the carrying value of the bond is more than the

  • Cash paid to seller
  • Face value of bond

  • Cash paid to seller - NO
  • Face value of bond - YES

The solutions approach is used to prepare the appropriate journal entry

  • Investment in bonds xxx 
  •       Interest receivable (or revenue) xxx
  •       Cash xxx

The Investment in bonds account is debited for the market value of the bond (price paid to seller) while the interest receivable account is debited for the amount of interest accrued from the previous interest payment date to the purchase date. The cash paid is the sum of the bond’s market value plus the accrued interest. Thus, the carrying value, which is represented by the amount in the investment account, is not greater than the cash paid. The fact that the bond was purchased at a premium, by definition, means that the market value (i.e., carrying value) is greater than the face value of the bond.

60

On September 1, year 1, after interest and amortization had been recorded, Oak Co. converted $1,000,000 of its 10% convertible bonds into 50,000 shares of $5 par common stock. The carrying amount of the bonds on the date of conversion was $1,200,000, and the market value of Oak’s common stock was $25 per share. Under the market value method, what amount should Oak record as a credit to additional paid-in capital?

  1. $750,000
  2. $950,000
  3. $1,000,000
  4. $1,250,000

$1,000,000

Under the market value method, a conversion of bonds to common stock is recorded at the market value of either the stock or the bonds, whichever is more reliable.  In this case, the market value of Oak’s stock is given. The common stock account is credited for the par value of the stock (50,000 × $5 = $250,000) and APIC is increased by market value minus par [50,000 × ($25 − $5) = $1,000,000].  Bonds payable and any related accounts are removed from the books, and a gain or loss equal to the difference between the market value of the stock and the book value of the bonds is recorded.  Oak sustained a loss on this redemption of $50,000, as shown in the entry recording the conversion

  • Loss on redemption 50,000 
  • Bonds payable 1,000,000 
  • Premium on BP 200,000 
    •  Common stock 250,000
    •  APIC 1,000,000

61

How would the amortization of premium on bonds payable affect each of the following?

  • Carrying value of bond
  • Net income

  • Carrying value of bond - Decrease
  • Net income - Increase

When the premium on bonds payable is amortized, the following entry is made:

  • Premium on bonds payable xxx
  •  Interest expense xxx

This entry has several effects. First, it reduces the amount of the premium. Because the carrying value of the bonds is the face value of the bonds plus the unamortized premium, amortization of the premium serves to reduce the carrying value. Second, amortization of the premium decreases interest expense, thus increasing net income.

62

Which of the following is generally associated with the terms of convertible debt securities?

  1. An interest rate that is lower than nonconvertible debt.
  2. An initial conversion price that is less than the market value of the common stock at time of issuance.
  3. A noncallable feature.
  4. A feature to subordinate the security to nonconvertible debt.

An interest rate that is lower than nonconvertible debt.

Convertible debt generally will have an interest rate that is lower than nonconvertible debt.

63

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?

  1. An interest expense that is less than the cash payment made to bondholders.
  2. An interest expense that is greater than the cash payment made to bondholders.
  3. A debit to the unamortized bond discount.
  4. A debit to the unamortized bond premium.

An interest expense that is greater than the cash payment made to bondholders.

Since the effective rate is higher than the coupon rate, the effective interest will be greater than the cash paid to the bondholders. If the stated rate of interest on a bond is less than the effective rate, the bond will sell at a discount. The interest paid is the coupon rate times the maturity value of the bond. The effective interest is the effective interest rate times the carrying value of the bond.

64

On June 30, year 1, Dean Company had outstanding 8%, $1,000,000 face value, 15-year bonds maturing on June 30, year 11. Interest is payable on June 30 and December 31. The unamortized balances on June 30, year 1, in the bond discount and bond issue costs accounts were $45,000 and $15,000, respectively. Dean reacquired all of these bonds at 93 on June 30, year 1, and retired them. How much gain should Dean report on this early extinguishment of debt?

  1. $10,000
  2. $25,000
  3. $40,000
  4. $70,000

$10,000

 

When the bonds are retired, the bonds payable, the unamortized discount, and the unamortized bond issue costs must be taken off the books.  Cash is credited for the amount paid (93% × $1,000,000 = $930,000), and the difference is the gain or loss on retirement.

  • Bonds payable1,000,000 
    •  Bond discount 45,000
    •  Bond issue costs 15,000
    •  Cash 930,000
    •  Gain 10,000

Net carrying amount of bonds ($1,000,000 – $45,000 – $15,000) $940,000

Cash paid (93% × $1,000,000) (930,000)

Gain $10,000

65

On January 1, year 1, Korn Co. sold to Kay Corp. $400,000 of its 10% bonds for $354,118 to yield 12%. Interest is payable semiannually on January 1 and July 1. What amount should Korn report as interest expense for the 6 months ended June 30, year 1?

  1. $17,706
  2. $20,000
  3. $21,247
  4. $24,000

$21,247

 

Under the interest method, interest expense is computed as

The interest payable (cash payments at stated rate) on 6/30/Y1 is $20,000 ($400,000 × 10% × 6/12), so the 6/30/Y1 journal entry is

  • Interest expense $21,247 
    •  Interest payable $20,000
    •  Discount on BP $1,247

66

In year 1, Jeremy Corporation issued 1,000 of its 8% $1,000 bonds for $1,040,000. The bonds were due on December 1, year 11. Jeremy did not elect the fair value option for reporting financial liabilities. On October 1, year 7, as part of its normal financing management strategy, Jeremy Corporation redeemed the bonds at a time when the carrying value of the bonds was $50,000 more than the cash paid to retire the bonds. Jeremy should report the $50,000 gain as

  1. Extraordinary gain on early extinguishment of debt.
  2. Discontinued operation.
  3. Interest income from the bond.
  4. Other income.

Other income.

Early extinguishments of debt are not routinely treated as extraordinary items. Therefore, Jeremy should record this as other income on the company’s income statement.

67

On July 1, year 1, Menzie Corporation sold a $1,000,000, 20-year, 10% bond issue for $1,060,000.  Each $1,000 bond had a detachable warrant eligible for the purchase of one share of Menzie’s $50 par value common stock for $60. Immediately after sale of the bonds, Menzie’s securities had the following market values:

  • 10% bonds without warrants $1,040
  • Warrants $20
  • Common stock, $50 par value $56

How much should Menzie credit to premium on bonds payable?

  1. $0
  2. $20,000
  3. $40,000
  4. $60,000

$40,000

ASC Topic 470 states that the proceeds of bonds issued with detachable stock warrants should be allocated to the bonds and warrants based upon relative fair market values at the time of issuance and accounted for separately.

  • FMV of bonds without warrants / FMV of bonds and warrants x Purchase price = Amount assigned to bonds
  • ($1,040,000 / $1,060,000) x $1,060,000 = $1,040,000

The bond premium is equal to $40,000 ($1,040,000 proceeds from issue of bonds − $1,000,000 face value of bonds).

68

How would the amortization of discount on bonds payable affect each of the following?

  • Carrying value of bond
  • Net income

  • Carrying value of bond - Increase
  • Net income - Decrease

​The solutions approach is to make the entry necessary to record the amortization of the discount.

  • Interest expense xxx (reduces income)
  •  Discount on bonds payable xxx (reduces discount)

Recall that the discount on bonds payable account usually carries a debit balance that reduces the carrying value of the bonds. This answer is correct because the credit to the discount account increases the carrying value of the bond, and the debit to interest expense will decrease net income.

69

On July 28, Vent Corp. sold $500,000 of 4%, eight-year subordinated debentures for $450,000. The purchasers were issued 2,000 detachable warrants, each of which was for one share of $5 par common stock at $12 per share. Shortly after issuance, the warrants sold at a market price of $10 each. What amount of discount on the debentures should Vent record at issuance?

  1. $50,000
  2. $60,000
  3. $70,000
  4. $74,000

$70,000

ASC Topic 470 states that the proceeds from the issuance of debt with detachable stock warrants should be allocated between the bonds and the warrants based upon their relative fair values at the time of issuance. In this case, the fair value of the bonds is not known, but the fair value of the warrants is $10 per warrant. Thus, the total fair value of the warrants is $20,000 ($10 × 2,000 warrants). The fair value of the debentures can be estimated to be $430,000 ($450,000 total proceeds – $20,000 fair value of warrants). This answer is correct because the face value of the bonds $500,000 less the fair value of the bonds of $430,000 equals the bond discount of $70,000.

70

Glen Corporation had the following long-term debt:

  • Sinking fund bonds, maturing in installments $1,100,000
  • Industrial revenue bonds, maturing in installments $900,000
  • Subordinated bonds, maturing on a single date $1,500,000

The total of the serial bonds amounted to

  1. $1,500,000
  2. $2,000,000
  3. $2,400,000
  4. $3,500,000

$2,000,000

Serial bonds are bond issues that mature in installments. Therefore, the total of the serial bonds is $2,000,000 ($1,100,000 + $900,000). The bonds which mature on a single date ($1,500,000) are called term bonds.

71

On March 1, year 1, Williams Corporation issued at 103 plus accrued interest, 100 of its 9%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. Williams paid bond issue costs of $5,000. Based on the information above, Williams would realize net cash receipts from the bond issuance of

  1. $98,000
  2. $99,500
  3. $103,000
  4. $104,500

$99,500

$100,000 of bonds are issued at 103 plus accrued interest (2 months, from January 1 to March 1) less bond issue costs of $5,000. The cash received for the bonds is 103% of $100,000, or $103,000. The cash received for the accrued interest is $1,500 ($100,000 × 9% × 2/12). Therefore, cash receipts total $99,500 ($103,000 + $1,500 – $5,000).

72

During year 1 Cain Corporation incurred the following costs in connection with the issuance of bonds:

  • Printing and engraving $15,000
  • Legal fees $80,000
  • Fees paid to independent accountants for registration information $10,000
  • Commissions paid to underwriter $150,000

What amount should be recorded as a deferred charge to be amortized over the term of the bonds?

  1. $15,000
  2. $150,000
  3. $245,000
  4. $255,000

$255,000

Per ASC 835-30-45-3, engraving and printing costs, legal and accounting fees, commissions, promotion costs, and other similar costs should be debited to a deferred charge account and amortized over the term of the bonds. All of the costs given fall into one of these categories, so a total of $255,000 ($15,000 + $80,000 + $10,000 + $150,000) should be recorded as bond issue costs.

73

A portion of the proceeds should be allocated to paid-in capital for bonds issued with

  • Detachable stock purchase warrants
  • Nondetachable stock purchase warrants

  • Detachable stock purchase warrants - YES
  • Nondetachable stock purchase warrants - NO

Bonds issued with stock purchase warrants are, in substance, composed of two elements, a debt element and a stockholders’ equity element. Per ASC Topic 470, proceeds from bonds issued with detachable stock purchase warrants should be allocated between the bonds and the warrants on the basis of their relative fair market values. Detachable warrants are often traded separately from the debt; thus, a market value is available. The amount allocated to the warrants should be accounted for as paid-in capital. Bonds issued with nondetachable stock purchase warrants must be surrendered in order to exercise the warrants. Since this inseparability prevents the determination of individual market values, no allocation is permitted under ASC Topic 470.

74

On January 1, year 1, Gilson Corporation issued for $1,030,000, 1,000 of its 9%, $1,000 callable bonds. The bonds are dated January 1, year 1, and mature on December 31, year 14. Interest is payable semiannually on January 1 and July 1. The bonds can be called by the issuer at 102 on any interest payment date after December 31, year 5. The unamortized bond premium was $14,000 at December 31, year 6, and the market price of the bonds was 99 on this date. Gilson does not elect the fair value option for reporting financial liabilities. In its December 31, year 6 balance sheet, at what amount should Gilson report the carrying value of the bonds?

  1. $1,020,000
  2. $1,016,000
  3. $1,014,000
  4. $ 990,000

$1,014,000

The carrying amount of the liability is the face amount of the bonds ($1,000,000) plus the unamortized bond premium ($14,000), or $1,014,000. The call provision (102), while disclosed, does not affect the carrying amount. The market price of the bonds (99) is neither disclosed nor used to compute the carrying amount.

75

On April 30, year 1, Witt Corp. had outstanding 8%, $1,000,000 face amount, convertible bonds maturing on April 30, year 5. Interest is payable on April 30 and October 31. On April 30, year 1, all these bonds were converted into 40,000 shares of $20 par common stock. On the date of conversion

  • Unamortized bond discount was $30,000.
  • Each bond had a market price of $1,080.
  • Each share of stock had a market price of $28.

Under the book value method, what amount should Witt record as a loss on conversion of bonds?

  1. $150,000
  2. $110,000
  3. $ 30,000
  4. $0

$0

Under the book value method, the common stock is recorded at the carrying amount of the converted bonds less any conversion costsNo gain or loss is ever recognized. The journal entry is:

  • Bonds payable $1,000,000 
    • Discount on BP $30,000
    • Common stock (40,000 × $20) $800,000
    • APIC (plug) $170,000

76

On April 1, year 1, Girard Corporation issued at 98 plus accrued interest, 200 of its 10%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. From the bond issuance Girard would realize net cash receipts of

  1. $191,000
  2. $196,000
  3. $198,500
  4. $201,000

$201,000

$200,000 of bonds are issued at 98 plus accrued interest (3 months, from January 1 to April 1). The cash received for the bonds is 98% of $200,000, or $196,000. The cash received for the accrued interest is $5,000 ($200,000 × 10% × 3/12). Therefore, cash receipts total $201,000 ($196,000 + $5,000).

77

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?

  1. $100,000
  2. $900,000
  3. $1,000,000
  4. $1,200,000

$900,000

Stockholders’ equity will increase by $900,000 ($100,000 par value + $800,000 additional paid-in capital).  If the bond is converted at book value, no gain or loss will be recorded on the conversion. The bond payable and the discount on bonds payable account are removed from the books, common stock is increased by par value of the shares issued, and the remaining amount is credited to additional paid-in capital.  The journal entry required for Stunt’s conversion of the bonds is

  • Bonds Payable $1,000,000
    • Discount on bonds payable $100,000           
    • Common stock $100,000 (par)
    • Additional paid-in capital $800,000 (plug)

78

On January 1, year 1, Jackson Corporations issued 100 of its 5% twenty-year, $1,000 bonds with detachable stock warrants at par. Each bond carried a detachable warrant for one share of Jackson’s common stock at a specified price of $20 per share. Immediately after the issuance, the market value of the bonds without the warrants was $108,000, and the market value of the warrants was $12,000. At what amount should Jackson record the warrants on January 1, year 1?

  1. $0
  2. $4,000
  3. $10,000
  4. $12,000

$10,000

ASC Subtopic 470-20 states that the proceeds of the bonds issued with detachable warrants are allocated between the bonds and the warrants based upon their relative FV at the time of issue.  In this case, the portion allocated to the warrants is $10,000, calculated as follows:  [$12,000 / ($108,000 + $12,000)] = 10% × $100,000 = $10,000. Therefore, the warrants are recorded at $10,000, and the bonds are recorded at $90,000.

79

On March 1, year 1, Clark Co. issued bonds at a discount. Clark incorrectly used the straight-line method instead of the effective interest method to amortize the discount.  How were the following amounts, as of December 31, year 1, affected by the error?

  • Bond carrying amount
  • Retained earnings

  • Bond carrying amount - Overstated
  • Retained earnings - Understated

When a company uses the effective interest method to amortize a discount on bonds payable, interest expense (which is based on the carrying value of the bonds) is lower in earlier years when compared to interest expense under the straight-line method. Therefore, the straight-line method results in understated retained earnings. Since more interest expense is recorded under the straight-line method, amortization of the discount on bonds payable will be greater under the straight-line method when compared to the effective interest method. Higher amortization results in a lower unamortized discount and, therefore, the carrying value of the bonds using the straight-line method is overstated.

80

A company issues bonds at 98, with a maturity value of $50,000. The entry the company uses to record the original issue should include which of the following?

  1. A debit to bond discount of $1,000.
  2. A credit to bonds payable of $49,000.
  3. A credit to bond premium of $1,000.
  4. A debit to bonds payable of $50,000.

A debit to bond discount of $1,000.

The journal entry required to record the bond issued at a discount is

  • Cash $49,000 
  • Discount on bond payable $1,000 
    • Bonds payable $50,000

81

Webb Co. has outstanding a 7%, 10-year $100,000 face-value bond. The bond was originally sold to yield 6% annual interest. Webb uses the effective interest rate method to amortize bond premium. On June 30, year 1, the carrying amount of the outstanding bond was $105,000. What amount of unamortized premium on bond should Webb report in its June 30, year 2 balance sheet?

  1. $1,050
  2. $3,950
  3. $4,300
  4. $4,500

$4,300

Use an amortization table to solve the problem.  

The bond premium amortization is the difference between these two amounts ($7,000 − $6,300 = $700). Therefore, the unamortized premium at 6/30/Y2 is $4,300 ($5,000 − $700).