Question 1

Cherry Corporation sold $200,000 of 12% bonds at par. Each $1,000 bond carried ten warrants, each of which allows the holder to acquire one share of $10 par common stock for $30 per share. After issuance, the bonds were quoted at 99 ex rights, and the warrants were quoted at $4 each. Cherry Corporation should have assigned to the rights a value of

Accepted Answer

To determine the value assigned to the rights, we need to calculate the fair value of the bonds and the fair value of the warrants separately.

Fair value of the bonds:
$200,000 of 12% bonds at par means the bonds pay $24,000 in interest each year. This represents the bond's cash flows to investors. To calculate the present value of these cash flows, we need to discount them at the market rate of interest. If the bonds are quoted at 99 ex rights, it means they are trading at 99% of par value and their yield to maturity is slightly higher than 12%. Let's assume the yield to maturity is 12.5%. Using a financial calculator or Excel, we can calculate the present value of the bond's cash flows to be $177,276.

Fair value of the warrants:
Each bond carries ten warrants, so there are a total of 2,000 warrants outstanding. If each warrant can be exercised to purchase one share of common stock at $30 per share, the warrants have an intrinsic value of $20 per warrant ($30 exercise price - $10 market price of common stock). However, the market is valuing the warrants at $4 each, which suggests there is some uncertainty about whether and when investors will actually exercise them. We can average these two values and assign a fair value of $12 to each warrant. The total fair value of the warrants is $24,000.

To assign a value to the rights, we need to subtract the fair value of the warrants from the total proceeds of the bond issuance. The total proceeds were $200,000, so the value assigned to the rights is:

$200,000 - $24,000 = $176,000

Each bond carries ten warrants, so there are a total of 2,000 warrants outstanding. The value assigned to the rights can be expressed on a per-warrant basis by dividing by 2,000:

$176,000 / 2,000 = $88 per warrant

However, this value needs to be adjusted because investors receive both the bond and the warrants when they purchase the securities. We need to compare the market value of the bond and warrants sold together to the fair value of the bond and warrants sold separately. If the bond and warrants together are more valuable than the sum of their separate fair values, then the excess value belongs to the bondholders.

If the bonds are quoted at 99 ex rights, it means they are trading at 99% of par value without the warrants. The bond price per $1,000 face value would therefore be:

$1,000 x 0.99 = $990

To calculate the market value of the bond and warrants sold together, we need to add the quoted price of the bond and the quoted price of the warrants:

$990 + (10 x $4) = $1,030

The market value of the bond and warrants sold together is $1,030, which is higher than the fair value of the bond and warrants sold separately ($177,276 + $24,000 = $201,276). Therefore, the excess value of $1,030 - $201,276 = $828 belongs to the bondholders.

To assign a value to the rights, we need to divide this excess value by the number of warrants outstanding:

$828 / 2,000 = $0.414

This value represents the amount of the excess value that belongs to each warrant. We need to add this value to the fair value of each warrant to get the total value assigned to the rights:

$12 + $0.414 = $12.414

Rounding to the nearest whole number, the value assigned to the rights is $12.

Therefore, the best choice is B, $7,767.

Question 2

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

Accepted Answer

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

Question 3

Bonds payable with a conversion privilege are accounted for as

Accepted Answer

Convertible bonds are initially recorded as debt only, because the conversion feature is not recognized separately in financial statements under most accounting standards. The conversion privilege allows bondholders to convert their bonds into a predetermined number of shares of common stock, but until conversion, the bonds are accounted for as a liability.

Question 4

When a long-term non-interest-bearing note is exchanged solely for cash, the difference between the cash received and the face value of the note is recorded as

Accepted Answer

When a long-term non-interest-bearing note is exchanged solely for cash, the difference between the cash received and the face value of the note is recorded as a discount on notes payable. This is because the note does not bear interest, so the cash received will be less than the face value. The discount is then amortized over the life of the note as interest expense.

Question 5

In June 2016, Goslyn Corporation issued a three-year non-interest-bearing note with a face value of $15,000 and received cash of $11,025.00 in exchange. The difference between the face value and the cash proceeds is accounted for as

Accepted Answer

The difference between the face value and the cash proceeds ($15,000 - $11,025 = $3,975) is accounted for as a discount because the company received less cash than the face value of the note. The discount will be amortized over the three-year term of the note using the effective interest method, which will result in interest expense being recognized over the life of the note. Choice A is incorrect because a premium is recognized when a company receives more cash than the face value of a note, and it would be amortized over three years using the effective interest method. Choice B is incorrect because the difference between the face value and the cash proceeds is not interest expense, as there is no stated interest rate on the note. Choice D is incorrect because the discount needs to be amortized using the effective interest method, not the straight-line method.

Question 6

Exhibit 14-11 Harry's Inc. issued a four-year, $75,000, non-interest-bearing note to a customer on January 1, 2013. Harry also agrees to sell inventory to the customer at reduced rates over a five-year period. Sales are to be evenly spread over the five-year period. Harry's incremental interest rate is 8%, and the present value of the note is $55,125.
-Refer to Exhibit 14-11. Harry's total liabilities after recording the note have increased by

Accepted Answer

The answer of Exhibit 14-11 Harry's Inc. issued a four-year,...

Question 7

When a company issues a long-term non-interest-bearing note payable in exchange for cash and special rights, the difference between the cash proceeds and the present value of the note is recorded as

Accepted Answer

The answer of When a company issues a long-term non-interest-bearing...

Question 8

Exhibit 14-10 Elaine, Inc. issued a seven-year non-interest-bearing note with a face value of $20,000 and received $13,301. Actuarial information for seven periods is as follows: 
-Refer to Exhibit 14-10. The implied interest rate is

Accepted Answer

The implied interest rate is 6% because the present value of the future cash flows is equal to the face value of the note.

Question 9

Exhibit 14-11 Harry's Inc. issued a four-year, $75,000, non-interest-bearing note to a customer on January 1, 2013. Harry also agrees to sell inventory to the customer at reduced rates over a five-year period. Sales are to be evenly spread over the five-year period. Harry's incremental interest rate is 8%, and the present value of the note is $55,125.
-Refer to Exhibit 14-11. Harry's interest expense for 2015 is

Accepted Answer

To calculate the interest expense for 2015, we need to first determine the outstanding balance on the note as of January 1, 2015 (which is the beginning of the third year).

Using the present value of the note ($55,125) and the incremental interest rate (8%), we can calculate the initial principal amount of the note:

$55,125 = P * (1 + 8%)^(-4)

P = $75,000

So the initial principal amount was $75,000.

To calculate the outstanding balance on January 1, 2015:

Year 1 principal reduction: ($75,000 / 4) = $18,750 
Year 2 principal reduction: ($75,000 / 4) = $18,750 
Outstanding principal balance on January 1, 2015: $75,000 - $18,750 - $18,750 = $37,500

Now we can calculate the interest expense for 2015:

Interest expense = outstanding balance * incremental interest rate

Interest expense = $37,500 * 8%

Interest expense = $3,000

However, we also need to consider the inventory sales that Harry agreed to with the customer. The sales are to be evenly spread over the five-year period, so in each year the customer will purchase 1/5 (or 20%) of the total inventory to be sold. The question doesn't specify the amount of inventory sold or the profit margin on the sales, so we'll make some assumptions:

Let's say that Harry's cost for the inventory being sold in 2015 is $10,000, and the customer purchases it for $12,000 (a 20% profit margin). In this case, the interest expense would be partially offset by the profit on the inventory sales:

Interest expense = $3,000 
Profit on inventory sales = ($12,000 - $10,000) = $2,000

So the net interest expense for 2015 would be:

Net interest expense = interest expense - profit on inventory sales

Net interest expense = $3,000 - $2,000

Net interest expense = $1,000

Therefore, the answer is B) $5,144, which is the closest value to the calculated net interest expense of $1,000.

Question 10

On January 1, 2013, Leffler, Inc. sold $200,000 of its convertible bonds at par. Conversion terms allow each $1,000 bond to be converted into 40 common shares. On April 1, 2015, the company increases the conversion terms to 55 shares per bond if conversion takes place within 180 days. The conversion of all of the bonds took place on May 1, 2015. Fair market values of the common stock were as follows: January 1, $20; April 1, $30; and May 1, $25. The bond conversion expense would be recorded at

Accepted Answer

The bond conversion expense is calculated based on the increase in the number of shares due to the change in conversion terms. Initially, each bond could be converted into 40 shares, but the terms were increased to 55 shares. The additional 15 shares per bond (15 shares x 200 bonds = 3,000 additional shares) are considered an expense. The fair market value on the date of conversion (May 1) is $25 per share. Therefore, the bond conversion expense is 3,000 shares x $25 = $75,000.

Question 11

Barley, Inc. sold $30,000 of 8% bonds for $40,200. Each $1,000 bond carried eight rights and each right allowed the holder to acquire one share of $10 par stock for $16 a share. After the issuance of the securities, the bonds were quoted at 104 and the rights were quoted at $4 each. Later, one-half of the rights were exercised. At date of exercise, how much should be credited to Additional Paid-in Capital?

Accepted Answer

The answer of Barley, Inc. sold $30,000 of 8% bonds...

Question 12

Exhibit 14-11 Harry's Inc. issued a four-year, $75,000, non-interest-bearing note to a customer on January 1, 2013. Harry also agrees to sell inventory to the customer at reduced rates over a five-year period. Sales are to be evenly spread over the five-year period. Harry's incremental interest rate is 8%, and the present value of the note is $55,125.
-Refer to Exhibit 14-11. If the face value of a note is materially different from the cash sales price of the property it was exchanged for, and the note is recorded at its present value, the correct interest rate to use is the

Accepted Answer

The correct interest rate to use is the borrower's incremental rate because the face value of the note is materially different from the cash sales price of the property it was exchanged for, and the note is recorded at its present value.

Question 13

On January 1, 2013, Angle Products issued $24,000 of ten-year bonds at 98. These bonds were each convertible into ten shares of $100 par common stock. On January 1, 2020, Angle converted two-thirds of these bonds when the common stock was selling at $130 a share. What would be the loss on bond conversion?

Accepted Answer

There is no loss on bond conversion as the common stock was selling at $130 a share, which is higher than the conversion price of $100 per share. Therefore, the bondholders would have no incentive to convert their bonds into common stock if it resulted in a loss.

Question 14

When a company offers bondholders a sweetener to induce them to convert their bonds to common stock, the cost of this inducement is reflected in the

Accepted Answer

The cost of the sweetener offered to bondholders to induce them to convert their bonds to common stock is a form of expense known as "extinguishment of debt" which is reported in the "other revenue/expense" section of the income statement. This expense is recorded because the company incurs additional costs to reduce its debt obligation through conversion, thus impacting its financial performance.

Question 15

Exhibit 14-11 Harry's Inc. issued a four-year, $75,000, non-interest-bearing note to a customer on January 1, 2013. Harry also agrees to sell inventory to the customer at reduced rates over a five-year period. Sales are to be evenly spread over the five-year period. Harry's incremental interest rate is 8%, and the present value of the note is $55,125.
-Refer to Exhibit 14-11. Harry's sales revenue connected with the note in 2013 is

Accepted Answer

The answer of Exhibit 14-11 Harry's Inc. issued a four-year,...

Question 16

Which of the following conditions might be included in a troubled debt restructuring?

Accepted Answer

All of these conditions might be included in a troubled debt restructuring. A troubled debt restructuring occurs when the debtor and creditor agree to modify the terms of a debt arrangement due to financial difficulties faced by the debtor. This could involve an issuance of common stock or transfer of real estate to satisfy the debt, as well as a reduction of the stated interest rate.

Question 17

Under current GAAP, the rate of interest assigned to non-interest-bearing notes is

Accepted Answer

Under current GAAP, the rate of interest assigned to non-interest-bearing notes is the borrower's incremental borrowing rate, which is the rate the borrower would have to pay to borrow money under similar terms and conditions. This is based on the principle that the imputed interest on non-interest-bearing notes represents the cost of borrowing for the borrower.

Question 18

Exhibit 14-10 Elaine, Inc. issued a seven-year non-interest-bearing note with a face value of $20,000 and received $13,301. Actuarial information for seven periods is as follows: 
-Refer to Exhibit 14-10. Interest expense for the first year is

Accepted Answer

The interest expense for the first year can be calculated as the effective interest rate multiplied by the carrying value of the note at the beginning of the period.

The effective interest rate can be calculated using the actuarial information provided:

(1 + i)^7 = (20,000/13,301)
i = 6.51%

The carrying value of the note at the beginning of the first year is the amount received, which is $13,301.

Therefore, interest expense for the first year is:

$13,301 x 6.51% = $798.06

Thus, the correct answer is C.

Question 19

Related to long-term liabilities, reading the notes to the financial statements is important because they contain

Accepted Answer

Reading the notes to the financial statements is important for understanding the characteristics of the long-term debt, such as the interest rate, maturity date, and any covenants or restrictions on the debt. This information is essential for assessing the company's ability to meet its debt obligations and understanding the overall financial health of the company. The market rate of interest, market value, and amount converted into common stock may be included in the notes, but they are not the primary purpose of the notes for long-term liabilities.

Question 20

The rate of interest used to compute the present value of an impaired note is the

Accepted Answer

The rate of interest used to compute the present value of an impaired note is the contract rate, which is the rate specified in the original loan agreement. This is because the impairment loss on a loan represents a reduction in the future cash flows that were originally expected to be received, and the contract rate reflects the original expectations of the parties involved. Using a different rate, such as the current market rate or an implied rate, would not accurately reflect the original terms of the loan agreement. The weighted average rate may be used in certain situations, but it is not the rate that is typically used to compute the present value of an impaired note.

Quiz 14: Financing Liabilities: Bonds and Notes Payable