Question 1

Interest expense is less than the interest paid when a bond is issued for a premium.

Accepted Answer

When a bond is issued for a premium, the issuer receives more cash upfront than the face value of the bond. However, the interest payments on the bond are based on the face value, not the premium amount. Therefore, the interest expense (calculated based on the stated interest rate and face value) will be less than the actual interest paid (which is based on the higher premium amount).

Question 2

When fair value is chosen for the reporting of a debt instrument this determination can be made after the bonds have been issued but prior to the issuance of the financial statements.

Accepted Answer

False

Question 3

Interest expense is more than interest paid when bonds are issued at par.

Accepted Answer

When bonds are issued at par, the interest expense equals the interest paid because the bonds are issued at their face value, and there is no premium or discount to amortize.

Question 4

A company could decide to call its bonds because it will eliminate any restrictions on operations from certain debt covenants.

Accepted Answer

Calling bonds allows a company to pay off debt and eliminate any restrictions that may have been placed on its operations from debt covenants. This gives the company more financial freedom to make decisions and pursue new opportunities.

Question 5

In the event of a debt restructuring the required disclosures are only for the related income tax effects associated with the debt.

Accepted Answer

In the event of a debt restructuring, the required disclosures are not only for the related income tax effects associated with the debt. Other disclosures may include the reasons for the restructuring, the terms of the new debt, the impact on financial statements, and any associated risks or uncertainties.

Question 6

Debt financing typically has a higher cost of capital than equity.

Accepted Answer

Debt financing often has a lower cost of capital than equity financing because interest payments on debt are tax-deductible, reducing the effective cost, and debt does not entail giving up any ownership control, as equity does.

Question 7

At the time of the issuance of a note payable the incremental interest rate is what one would pay for similar financing.

Accepted Answer

The incremental interest rate is the rate that a borrower would have to pay currently for a similar type of loan. Therefore, the statement is true.

Question 8

As a requirement of GAAP the interest expense associated with a note payable is recorded in the operating activities of the cash flow statement.

Accepted Answer

Interest expense is recorded in the operating activities section of the cash flow statement because it is considered an operating expense.

Question 9

A company may want to increase its equity capital at a later date in time, in order to accomplish this goal the company decides to issue convertible debt.

Accepted Answer

Issuing convertible debt allows the company to raise equity capital in the future by giving the debt holders the option to convert their debt into equity at a later stage.

Question 10

Serial bonds come due in installments in periodic future dates.

Accepted Answer

Serial bonds are issued with multiple maturity dates, meaning they come due in installments on specific future dates.

Question 11

If a company is having trouble paying its obligations a modification of terms can be granted in the form of interest rate reduction, maturity date extension, and even a reduction in the amount owed.

Accepted Answer

This statement is true. A modification of terms can include an interest rate reduction, maturity date extension, or reduction in the amount owed to help a struggling company pay its obligations.

Question 12

When computing the amortization for a discount or premium for a bond issue only the effective amortization method is permissible under IFRS. Under GAAP however, the straight line or the effective interest method can be used with no regard to materiality.

Accepted Answer

The answer of When computing the amortization for a discount...

Question 13

Debenture Bonds are only issued to companies with an excellent credit rating.

Accepted Answer

Debenture bonds can be issued to companies with varying credit ratings, not only those with excellent credit ratings. The credit rating of a company can have an impact on the interest rate and terms of the debenture bond, but it does not prohibit a company from issuing them.

Question 14

If the contract rate of interest is less than the effective interest rate the issuer of the bonds will record a premium.

Accepted Answer

If the contract rate of interest is less than the effective interest rate, the bonds will be issued at a discount, not a premium. A premium occurs when the contract rate is higher than the effective rate.

Question 15

GAAP considers debt extinguished if one of the following occurs:
* the creditor has been paid in full and has released the company from any further obligations.
* the debtor is legally released from being the primary responsible party to the debt.

Accepted Answer

This is correct according to GAAP guidelines for debt extinguishment. If either of these two conditions are met, the debt is considered extinguished and should be removed from the company's financial statements.

Question 16

Companies report cash flows associated with long term liability transactions in the investing section of the statement of cash flows, because the money was an investment in the future of the company.

Accepted Answer

Companies report cash flows associated with long term liability transactions in the financing section of the statement of cash flows, not the investing section.

Question 17

A company looking to issue debt instead of equity may want to consider debt due to favorable tax benefits.

Accepted Answer

Interest payments on debt are tax deductible, which can result in a lower overall tax burden for the company. In contrast, dividends paid to shareholders after issuing equity are not tax deductible.

Question 18

When a zero coupon bond is issued, interest is remitted periodically over the life of the bonds. The interest remitted is the present value of the face value of the bonds.

Accepted Answer

When a zero coupon bond is issued, no interest is remitted periodically over the life of the bond. Instead, the bond is issued at a discount to its face value, and the full face value is paid to the bondholder upon maturity. The difference between the discounted purchase price and the face value represents the interest earned on the bond.

Question 19

When the contract rate of interest is greater than the market rate of interest the issuer will record a premium on bonds payable.

Accepted Answer

This statement is true. When the contract rate of interest on a bond is higher than the market rate of interest, the bond is sold at a premium. The issuer will record this premium as a liability in the bond payable account.

Question 20

Notes payable can be structured in various ways, but GAAP recognizes the underlying economics therefore requiring the borrowers to record the note at its present value and to record interest based upon the straight line method of amortization.

Accepted Answer

Under GAAP, interest on notes payable is typically recorded using the effective interest method, not the straight-line method, to reflect the true cost of borrowing over time.

Quiz 14: Financing Liabilities: Bonds and Notes Payable