Question 1

When bonds are called for retirement,any excess of the bonds' call price over the bonds' carrying value is reported as a gain on the income statement.

Accepted Answer

When bonds are called for retirement, any excess of the bonds' call price over the bonds' carrying value is reported as a loss, not a gain, on the income statement. Conversely, if the carrying value exceeds the call price, the difference is reported as a gain.

Question 2

The market interest rate is the rate that an issuer of bonds actually will have to bear and that an investor (purchaser)actually will earn over the bond's life.

Accepted Answer

The statement is true. The market interest rate is the prevailing rate in the market at the time of issuance of a bond, and it directly affects the yield of the bond for the investors. The issuer of the bond also has to pay interest at this rate to the bondholders.

Question 3

Issuing bonds at a discount has the effect of increasing interest expense above the face amount of interest.

Accepted Answer

When a bond is issued at a discount, it means the bond is sold for less than its face value. This discount is amortized over the life of the bond and increases the effective interest expense amount. Therefore, the interest expense will be higher than the face amount of interest.

Question 4

When bonds are converted to stock,any excess carrying value of the bonds over the par value of the stock is to be recorded as Additional Paid-in Capital.

Accepted Answer

When bonds are converted to stock, any excess carrying value of the bonds over the par value of the stock is recorded as Additional Paid-in Capital. This is because the carrying value of the bonds represents the amount paid by investors above the par value of the bonds, and this amount is considered a capital contribution to the company when the bonds are converted to stock.

Question 5

If bonds are retired by an issuer by purchase on the open market at a price below the bonds' carrying value,a loss will result.

Accepted Answer

When bonds are retired by an issuer by purchase on the open market at a price below their carrying value, a gain will result because the issuer is paying less than the amount at which the bonds were recorded on the books.

Question 6

The amount of unamortized discount at the end of an interest period is equal to the amount of the unamortized discount at the beginning of the period minus the amount of discount that was amortized during the period.

Accepted Answer

This is the correct formula for calculating the amount of unamortized discount at the end of an interest period. It is calculated by subtracting the amount of discount that was amortized during the period from the amount of unamortized discount at the beginning of the period.

Question 7

Under the effective interest method of amortizing a bond discount,the bond interest expense recorded for each period decreases over the life of the bond.

Accepted Answer

Under the effective interest method, the bond interest expense actually increases over the life of the bond because it applies a constant interest rate to the carrying amount of the bond, which increases as the discount is amortized.

Question 8

The carrying value of a bond issued at a premium is calculated at any given point in time by adding the balance of the unamortized premium to the bond's face value.

Accepted Answer

This is correct. The carrying value of a bond issued at a premium is the sum of the bond's face value and the unamortized premium amount.

Question 9

It is the issuer rather than the bond holder who may exercise the call feature of a callable bond.

Accepted Answer

The call feature of a callable bond allows the issuer to redeem the bonds before their maturity date. Therefore, it is the issuer who has the right to exercise the call feature, not the bond holder.

Question 10

When there are material differences between the results of using the straight-line method and using the effective interest method of amortization,the effective interest method should be used.

Accepted Answer

The effective interest method is required when there are material differences between it and the straight-line method. This is because the effective interest method more accurately reflects the true interest expense over the life of the bond or loan. Therefore, it is generally considered to be the more appropriate method to use in such cases.

Question 11

The effective interest method produces a constant dollar amount of bond interest expense to be reported each interest period.

Accepted Answer

The effective interest method produces a varying amount of bond interest expense each period because it applies the market rate of interest at issuance to the outstanding balance of the bond, which changes as the bond is paid down or amortizes.

Question 12

When the effective interest method of amortization is used for a bond premium,the amount of premium to be amortized for a period is calculated by subtracting the amount of bond interest expense for the period from the amount of cash to be paid for interest for the same period.

Accepted Answer

This is correct. The effective interest method of amortization calculates the amount of premium to be amortized each period by subtracting the amount of bond interest expense for the period from the amount of cash paid for interest. This helps to evenly spread the premium over the life of the bond.

Question 13

The calculation of cash for interest to be paid each interest period in connection with a bond payable is not influenced by any premium or discount upon issuance.

Accepted Answer

The calculation of cash for interest to be paid each interest period is based purely on the stated coupon rate and face value of the bond, and is not affected by any premium or discount that may have been incurred upon issuance of the bond. Therefore, the statement is true.

Question 14

A bond discount is a component of interest cost because it represents the amount in excess of the issue price that a corporation must pay on the maturity date.

Accepted Answer

A bond discount occurs when bonds are issued for less than their face value. The discount represents additional interest cost to the issuer, as it must be amortized over the life of the bond, effectively increasing the interest expense recognized.

Question 15

Regardless of whether the straight-line method or the effective interest method is used,the carrying value of a term bond issued at a discount will increase continually over the life of the bond.

Accepted Answer

The carrying value of a term bond issued at a discount increases over time because the discount is amortized to interest expense, gradually reducing the discount and increasing the carrying value of the bond to its face value at maturity.

Question 16

When the effective interest method of amortization is used,the amount of bond interest expense for a given period is calculated by multiplying the face interest rate by the bond's carrying value at the beginning of the given period.

Accepted Answer

When the effective interest method of amortization is used, the amount of bond interest expense for a given period is calculated by multiplying the effective interest rate by the bond's carrying value at the beginning of the given period. The effective interest rate is calculated based on the current market interest rates and the original issue price of the bond.

Question 17

Total interest cost for a bond issued at a premium equals the total of the periodic interest payments plus the premium.

Accepted Answer

Total interest cost for a bond issued at a premium equals the total of the periodic interest payments minus the premium, because the premium effectively reduces the cost of borrowing over the life of the bond.

Question 18

When a bond has been issued at a discount,the carrying value at the end of one period is equal to the carrying value at the beginning of the period minus the amount of discount that was amortized during the period.

Accepted Answer

When a bond is issued at a discount, the carrying value at the end of one period is equal to the carrying value at the beginning of the period plus the amount of discount that was amortized during the period. The amortization of the discount increases the carrying value of the bond over time until it reaches its face value at maturity.

Question 19

When a bond issue is converted into common stock,total contributed capital is increased by the fair market value of the bonds converted.

Accepted Answer

Total contributed capital is increased by the par value of the common stock issued in the conversion, not by the fair market value of the bonds converted.

Question 20

When bonds are converted to stock,no gain or loss is recognized.

Accepted Answer

According to the IRS, when bonds are converted to stock, no gain or loss is recognized. This is because the value of the bonds is essentially being exchanged for the value of the stock, without any cash changing hands. Therefore, there is no taxable gain or loss from the transaction.

Quiz 14: Long Term Liabilities