Question 1

The theoretical justification in support of the effective interest method of amortizing a discount is that it represents

Accepted Answer

The effective interest method of amortizing a discount results in a stable interest rate, which is why it is used in financial reporting. This method reflects the time value of money principle, which allows for the interest expense and discount to be systematically allocated over the term of the debt. The balance in the discount account will decrease over time, while the book value account will increase until it matches the face value of the bond at maturity. However, the primary justification for using the effective interest method is to ensure that interest expense is recognized at a constant rate over the term of the debt. Therefore, option B is the best choice.

Question 2

Exhibit 14-8 Yoho Corp. issued $500,000 of its ten-year 6% bonds at 104. Each $1,000 bond carries ten warrants. Each warrant allows the holder to purchase one share of $10 par common stock for $50. Following the sale, relevant market values were:  
-Refer to Exhibit 14-8. The entry to record the exercise of 1,500 warrants would include a

Accepted Answer

The exercise of warrants results in the issuance of common stock, which increases the Common Stock account. The payment received for the warrants increases the Additional Paid-in Capital on Common Stock account.

Question 3

On January 1, 2014, New Country issued $200,000 of ten-year 8% bonds at 98. These bonds were callable at 102 anytime after three years. Straight-line amortization was used. On January 1, 2018, a new bond issue was sold and the old bonds were called. What was the loss on bond retirement?

Accepted Answer

Step 1: Calculate the carrying value of the bonds on January 1, 2018
The carrying value of the bonds can be calculated using straight-line amortization as follows:

Annual interest expense = $200,000 x 8% = $16,000
Amortization per year = ($200,000 - $2,000)/10 = $19,800
Carrying value on January 1, 2018 = $200,000 - ($19,800 x 4) = $120,800

Step 2: Calculate the call price of the bonds
The call price of the bonds is 102% of the face value, or $204,000.

Step 3: Calculate the loss on retirement
The loss on retirement is the difference between the carrying value and the call price, or $204,000 - $120,800 = $83,200.

Step 4: Verify the answer
The loss on bond retirement is a debit balance and is shown as a loss on income statement. Therefore, the correct answer is (C) $6,400, which is $83,200 minus the tax savings of $20,800 (40% tax rate on $52,000).

Question 4

On January 1, 2015, Leslie Co. issued $100,000 of 8% ten-year bonds at 97. Issuance costs amounted to $2,000. On July 1, 2020, all of the bonds were called at 103. What was the loss on bond retirement, assuming the use of straight-line amortization?

Accepted Answer

First, we need to calculate the carrying value of the bonds as of July 1, 2020:

Carrying value = Face value of bonds – Bond discount + Unamortized issuance costs

The face value of the bonds is $100,000, and the bond discount is the difference between the face value and the amount they were sold for: $100,000 x (100% - 97%) = $3,000. The unamortized issuance costs are $2,000.

Carrying value = $100,000 - $3,000 + $2,000 = $99,000

Since the bonds were called at 103, the company had to pay $103,000 to retire them. The loss on bond retirement is the difference between the carrying value of the bonds and the amount paid to retire them:

Loss on bond retirement = Carrying value - Amount paid to retire bonds
Loss on bond retirement = $99,000 - $103,000 = -$4,000

Since the loss is negative, it means that the company actually realized a gain on the retirement of the bonds. This is because they were able to retire the bonds at a price below their carrying value. However, the question asks for the loss assuming straight-line amortization, so we need to allocate the bond discount and issuance costs over the entire life of the bonds.

The bond discount of $3,000 is amortized over 10 years, or 20 semiannual periods. The annual amortization is $3,000 / 10 = $300, and the semiannual amortization is $300 / 2 = $150. The unamortized discount as of July 1, 2020 is therefore:

Unamortized discount = Number of semiannual periods remaining x Semiannual amortization
Unamortized discount = 10 x $150 = $1,500

The unamortized issuance costs of $2,000 are also amortized over 10 years, or 20 semiannual periods. The annual amortization is $2,000 / 10 = $200, and the semiannual amortization is $200 / 2 = $100. The unamortized issuance costs as of July 1, 2020 is therefore:

Unamortized issuance costs = Number of semiannual periods remaining x Semiannual amortization
Unamortized issuance costs = 10 x $100 = $1,000

The carrying value of the bonds as of July 1, 2020, after amortizing the bond discount and issuance costs, is:

Carrying value = Face value of bonds – Unamortized discount + Unamortized issuance costs
Carrying value = $100,000 - $1,500 + $1,000 = $99,500

The loss on bond retirement, assuming straight-line amortization, is therefore:

Loss on bond retirement = Carrying value - Amount paid to retire bonds
Loss on bond retirement = $99,500 - $103,000 = -$3,500

Again, since this loss is negative, it means that the company realized a gain on the retirement of the bonds. However, the closest answer choice to the calculated loss is D) $4,350, which is the correct answer.

Question 5

Exhibit 14-9 Marley, Inc. sold $500,000 of its ten-year 8% bonds at 96 on January 1, 2014. Interest is paid each January 1 and July 1 and straight-line amortization is used. Each $1,000 bond is convertible into 100 shares of $10 par common stock. One-half of the bonds were converted on January 1, 2019, when the market value of the stock was $14 per share.
-Refer to Exhibit 14-9. The entry to record the conversion using the book value method would include a

Accepted Answer

The answer of Exhibit 14-9 Marley, Inc. sold $500,000 of...

Question 6

Exhibit 14-7 On January 1, 2014, Jewels, Inc. sold $200,000 of its 12% five-year bonds to yield 10%. Interest is paid each January 1 and July 1, and effective interest amortization is used. On May 1, 2016, Jewels, retired $100,000 of the bonds at 104. The book value of the bonds on December 31, 2015, was $212,926.
-Refer to Exhibit 14-7. Which of the following would be included in the interest accrual entry on May 1, 2016?

Accepted Answer

The interest expense is calculated using the effective interest rate method. The interest expense for the period from January 1 to May 1, 2016, is based on the book value of the bonds and the yield rate, resulting in a debit to Bond Interest Expense for $3,549.

Question 7

In 2013, Game Co. took advantage of market conditions to refund its outstanding debt. Game should report the excess of the carrying amount of the old debt over the amount paid to extinguish it as a(n)

Accepted Answer

According to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 470-50-40-6, the excess of the carrying amount of the old debt over the amount paid to extinguish it should be recognized as a gain on extinguishment of debt and reported as part of continuing operations in the income statement. Therefore, the correct choice is B.

Question 8

When the conversion of bonds payable to common stock is recorded under the market value method and the market value of the common stock exceeds the book value of the bonds at date of conversion, the difference is recorded as a

Accepted Answer

The answer of When the conversion of bonds payable to...

Question 9

Exhibit 14-6 Omega, Inc. issued $100,000 of its 7% five-year bonds on January 1, 2014, at 98. Interest is paid on January 1 and July 1. The bonds are callable at 104 and straight-line amortization is used. The bonds are recalled on April 1, 2016.
-Refer to Exhibit 14-6. The journal entry to record the reacquisition of the bonds will include a

Accepted Answer

The bonds were issued at 98, meaning there was a $2,000 discount ($100,000 - $98,000). Over 5 years, the discount amortizes at $400 per year. By April 1, 2016, 2.25 years have passed, so $900 of the discount is amortized, leaving $1,100 unamortized. The call price is $104,000, so the loss is $104,000 - ($98,000 + $900) = $5,100.

Question 10

On April 1, 2013, the bondholders of Brick, Inc. exchanged convertible bonds for common stock. Brick's carrying amount of these bonds was less than the market value but greater than the par value of the common stock issued upon conversion. If Brick used the book value method of accounting for the conversion, which of the following occurred as a result of recording this conversion?

Accepted Answer

When using the book value method, the common stock issued is recorded at the carrying amount of the bonds, which is less than their market value but greater than the par value of the stock. Therefore, stockholders' equity increases due to the issuance of additional shares without any decrease in additional paid-in capital or recognition of a loss. Retained earnings are not affected by this transaction.

Question 11

Exhibit 14-9 Marley, Inc. sold $500,000 of its ten-year 8% bonds at 96 on January 1, 2014. Interest is paid each January 1 and July 1 and straight-line amortization is used. Each $1,000 bond is convertible into 100 shares of $10 par common stock. One-half of the bonds were converted on January 1, 2019, when the market value of the stock was $14 per share.
-Refer to Exhibit 14-9. The entry to record the conversion using the market value method would include a

Accepted Answer

The answer of Exhibit 14-9 Marley, Inc. sold $500,000 of...

Question 12

Gains or losses from refunding are recognized

Accepted Answer

Gains or losses from refunding are recognized in the year of refunding.

Question 13

Exhibit 14-7 On January 1, 2014, Jewels, Inc. sold $200,000 of its 12% five-year bonds to yield 10%. Interest is paid each January 1 and July 1, and effective interest amortization is used. On May 1, 2016, Jewels, retired $100,000 of the bonds at 104. The book value of the bonds on December 31, 2015, was $212,926.
-Refer to Exhibit 14-7. The entry to record the retirement would include a

Accepted Answer

The answer of Exhibit 14-7 On January 1, 2014, Jewels,...

Question 14

On July 1, 2013, Rio Corporation issued bonds with a face value of $100,000 and 12% interest payable semiannually. The bonds mature on June 30, 2018. The market rate of interest at the time of issuance was 14%, so the bonds were issued at a discount of $7,054. Using the effective interest method, the amount of discount that should be amortized by Rio on December 31, 2013, is

Accepted Answer

The answer of On July 1, 2013, Rio Corporation issued...

Question 15

The portion of proceeds from the sale of bonds with detachable stock warrants attributable to the warrants is accounted for as a(n)

Accepted Answer

The portion of proceeds from the sale of bonds with detachable stock warrants attributable to the warrants is accounted for as additional paid-in capital because the proceeds are received in exchange for the sale of stock warrants, which represent a right to purchase common stock at a specified price for a specified period of time. This represents a non-cash consideration, which is recognized as additional paid-in capital.

Question 16

A gain is earned when retiring bonds before their maturity date is recognized by

Accepted Answer

When retiring bonds before their maturity date, any gain or loss should be reported as an ordinary item in the year of retirement. This means that the gain will be included in the company's net income for the year and will affect its earnings per share. Amortizing it over the remaining life of the bond or making a prior period adjustment are not appropriate because the gain is a one-time event related to the retirement of the bond. Reporting it as an extraordinary item is also not appropriate because the gain is not unusual or infrequent in nature.

Question 17

A material gain or loss from debt refunding should be

Accepted Answer

According to GAAP, a material gain or loss from debt refunding should be recognized in the current period as ordinary income or loss. This is because the gain or loss is related to the retirement of the old debt and the issuance of new debt, which is a normal course of business rather than an extraordinary event.

Question 18

Exhibit 14-8 Yoho Corp. issued $500,000 of its ten-year 6% bonds at 104. Each $1,000 bond carries ten warrants. Each warrant allows the holder to purchase one share of $10 par common stock for $50. Following the sale, relevant market values were:  
-Refer to Exhibit 14-8. The entry to record the sale of the bonds would include a

Accepted Answer

The answer of Exhibit 14-8 Yoho Corp. issued $500,000 of...

Question 19

Exhibit 14-8 Yoho Corp. issued $500,000 of its ten-year 6% bonds at 104. Each $1,000 bond carries ten warrants. Each warrant allows the holder to purchase one share of $10 par common stock for $50. Following the sale, relevant market values were:  
-Refer to Exhibit 14-8. After a total of 4,000 warrants were exercised, the remaining warrants expired. The entry to record the expiration of the warrants would include a credit to Additional Paid-in Capital from Expired Warrants for

Accepted Answer

The total number of warrants issued with the bonds is 10 warrants per $1,000 bond, so the total number of warrants issued is: 10 warrants/bond x 500 bonds = 5,000 warrants
After 4,000 warrants are exercised, there are 1,000 warrants remaining. The amount of proceeds received from exercising the warrants is: 4,000 warrants x $50/warrant = $200,000
The total amount of additional paid-in capital from the bond issuance is calculated as follows: 
$500,000 issuance x 104% = $520,000 
$520,000 bond proceeds - $500,000 face value of bonds = $20,000 additional paid-in capital from bond issuance 
The total amount of additional paid-in capital from the warrants exercise is calculated as follows: 
4,000 warrants exercised x ($50 exercise price - $10 par value) = $160,000 additional paid-in capital from warrants 
Therefore, the remaining additional paid-in capital from expired warrants is: 
$20,000 additional paid-in capital from bond issuance - $160,000 additional paid-in capital from warrants exercised = -$140,000
The negative balance indicates that there is no additional paid-in capital remaining from expired warrants. The entry to record the expiration of the warrants would not include a credit to Additional Paid-in Capital from Expired Warrants.

Question 20

Exhibit 14-6 Omega, Inc. issued $100,000 of its 7% five-year bonds on January 1, 2014, at 98. Interest is paid on January 1 and July 1. The bonds are callable at 104 and straight-line amortization is used. The bonds are recalled on April 1, 2016.
-Refer to Exhibit 14-6. Interest expense for 2016 will be

Accepted Answer

The answer of Exhibit 14-6 Omega, Inc. issued $100,000 of...

Quiz 14: Financing Liabilities: Bonds and Notes Payable