Question 1

When a bond sells at a premium:
A) The contract rate is above the market rate.
B) The contract rate is equal to the market rate.
C) The contract rate is below the market rate.
D) It means that the bond is a zero coupon bond.
E) The bond pays no interest.

Accepted Answer

When a bond sells at a premium, it means that investors are willing to pay more than the face value of the bond because the contract rate (i.e., coupon rate) is higher than the current market rate. Therefore, choice A is the correct option.

Question 2

A corporation borrowed $125,000 cash by signing a 5-year, 9% installment note requiring equal annual payments each December 31 of $32,136. What journal entry would the issuer record for the first payment?
A) Debit Interest Expense $7,136; debit Notes Payable $25,000; credit Cash $32,136.
B) Debit Notes Payable $32,136; debit Interest Payable $11,250; credit Cash $43,386.
C) Debit Interest Expense $11,250; debit Notes Payable $20,886; credit Cash $32,136.
D) Debit Notes Payable $32,136; credit Cash $32,136.
E) Debit Notes Payable $11,250; credit Cash $11,250.

Accepted Answer

The first payment on an installment note consists of both principal and interest.
The principal payment is calculated as the total amount borrowed divided by the number of payments, which in this case is $125,000/5 = $25,000.
The interest portion of the payment is calculated as the current outstanding balance of the loan multiplied by the interest rate, which in this case is ($125,000 - $25,000) x 9% = $9,000 per year. 
Since the payments are equal amounts of $32,136, the interest portion of the payment must decrease each year as the outstanding balance of the loan is reduced by the amount of the principal payment.

Therefore, the journal entry for the first payment on December 31 should be:

Debit Interest Expense $11,250 ($9,000 for interest + ($125,000-$25,000)/5 x 9% for first year amortization)
Debit Notes Payable $20,886 ($32,136-$11,250)
Credit Cash $32,136

Question 3

A company issued 7%, 5-year bonds with a par value of $100,000. The market rate when the bonds were issued was 7.5%. The company received $97,947 cash for the bonds. Using the effective interest method, the amount of interest expense for the first semiannual interest period is:
A) $3,500.00.
B) $3,673.01.
C) $3,705.30.
D) $7,000.00.
E) $7,346.03.

Accepted Answer

The interest expense using the effective interest method is calculated by multiplying the carrying amount of the bonds at the beginning of the period by the market interest rate at the time of issuance. Since the market rate is 7.5% annually, for a semiannual period it is 3.75% (7.5% / 2). The carrying amount of the bonds at issuance is $97,947. Therefore, the interest expense for the first semiannual period is $97,947 * 3.75% = $3,673.01.

Question 4

A company issued 5-year, 7% bonds with a par value of $100,000. The market rate when the bonds were issued was 6.5%. The company received $101,137 cash for the bonds. Using the effective interest method, the amount of recorded interest expense for the first semiannual interest period is:
A) $3,500.00.
B) $7,000.00.
C) $3,286.95.
D) $6,573.90.
E) $1,750.00.

Accepted Answer

Under the effective interest method of bond amortization, interest expense is calculated using the effective interest rate, which is the market rate at the time of issuance.

Effective interest rate = (Total interest payments over the life of the bond + Discount or premium) / Face value of bond

Total interest payments = 5 years x 2 semiannual periods per year x $100,000 x 7% = $70,000 
Discount = $101,137 - $100,000 = $1,137

Effective interest rate = ($70,000 + $1,137) / $100,000 = 7.137%

For the first semiannual interest period, interest expense is calculated by multiplying the carrying value of the bond (which is the face value plus or minus any unamortized discount or premium) by the effective interest rate:

Carrying value = $100,000 
Interest expense = $100,000 x 7.137% / 2 = $3,286.95

Therefore, the answer is C.

Question 5

A bond sells at a discount when the:
A) Contract rate is above the market rate.
B) Contract rate is equal to the market rate.
C) Contract rate is below the market rate.
D) Bond has a short-term life.
E) Bond pays interest only once a year.

Accepted Answer

A bond sells at a discount when the contract rate (also known as the coupon rate) is below the market rate. This means that the bond is offering a lower interest rate than what is currently available in the market, making it less attractive to investors. As a result, the bond will sell at a discount in order to compensate for the lower interest rate.

Question 6

A company retires its bonds at 105. The face value is $100,000 and the carrying amount of the bonds at the retirement date is $103,745. The issuer's journal entry to record the retirement will include a:
A) Debit to Premium on Bonds.
B) Credit to Premium on Bonds.
C) Debit to Discount on Bonds.
D) Credit to Gain on Bond Retirement.
E) Credit to Bonds Payable.

Accepted Answer

The carrying amount of the bonds ($103,745) is less than the amount paid to retire the bonds ($105,000), resulting in a gain on bond retirement. Therefore, the company will debit Premium on Bonds for the difference between the carrying amount and the face value ($100,000 - $103,745 = $3,745) and credit Gain on Bond Retirement for the difference between the amount paid to retire the bonds and the carrying amount ($105,000 - $103,745 = $1,255).

Question 7

The effective interest amortization method:
A) Allocates bond interest expense over the bond's life using a changing interest rate.
B) Allocates bond interest expense over the bond's life using a constant interest rate.
C) Allocates a decreasing amount of interest over the life of a discounted bond.
D) Allocates bond interest expense using the current market rate for each interest period.
E) Is not allowed by the IASB.

Accepted Answer

The effective interest amortization method allocates bond interest expense over the bond's life using a constant interest rate. This rate is calculated as the market interest rate at the time of issuing the bond adjusted for any transaction costs or premiums/discounts. This method is in accordance with International Financial Reporting Standards (IFRS) and International Accounting Standards Board (IASB) requirements.

Question 8

A company may retire bonds by:
A) Exercising a call option.
B) The holders converting them to shares.
C) Purchasing the bonds on the open market.
D) Paying them off at maturity.
E) All of these.

Accepted Answer

A company may retire bonds in any of the ways mentioned in the options. They can exercise a call option, where they can buy back the bonds before their maturity date. The bondholders can also convert their bonds into shares, which gives the company equity financing. The company can purchase the bonds on the open market, which is known as an open market repurchase. Lastly, the company can pay off the bonds at maturity, which is the most common method of retiring bonds.

Question 9

Amortizing a bond discount:
A) Allocates a portion of the total discount to interest expense each interest period.
B) Increases the market value of the Bonds Payable.
C) Decreases the Bonds Payable account.
D) Decreases interest expense each period.
E) Increases cash flows from the bond.

Accepted Answer

Amortizing a bond discount involves allocating a portion of the total discount to interest expense each interest period. This results in an increase in the interest expense and a decrease in the carrying value of the bond. Therefore, choice A is the correct answer. Choices B, C, D, and E are incorrect as they do not accurately describe the effects of amortizing a bond discount.

Question 10

The Discount on Bonds Payable account is:
A) A liability.
B) A contra liability.
C) An expense.
D) A contra expense.
E) A contra equity.

Accepted Answer

The Discount on Bonds Payable account is a contra liability account. It shows the amount of discount that was given when the bonds were issued. The discount is amortized over the life of the bonds and reduces the amount of interest expense that is recorded each period. Therefore, it is a contra liability account as it reduces the amount of the underlying liability - the bonds payable.

Question 11

A corporation issued 8% bonds with a par value of $1,000,000, receiving a $20,000 premium. On the interest date 5 years later, after the bond interest was paid and after 40% of the premium had been amortized, the corporation purchased the entire issue on the open market at 99 and retired it. The gain or loss on this retirement is:
A) $0.
B) $10,000 gain.
C) $10,000 loss.
D) $22,000 gain.
E) $22,000 loss.

Accepted Answer

The corporation received a $20,000 premium, and 40% of it was amortized, leaving $12,000 unamortized. The bonds were retired at 99, which means they were bought back for $990,000. The carrying amount of the bonds is $1,012,000 ($1,000,000 par value + $12,000 unamortized premium). The gain on retirement is $1,012,000 - $990,000 = $22,000.

Question 12

A company received cash proceeds of $206,948 on a bond issue with a par value of $200,000. The difference between par value and issue price for this bond is recorded as a:
A) Credit to Interest Income.
B) Credit to Premium on Bonds Payable.
C) Credit to Discount on Bonds Payable.
D) Debit to Premium on Bonds Payable.
E) Debit to Discount on Bonds Payable.

Accepted Answer

The difference between the par value of the bond and the issue price is recorded as either a premium or discount on bonds payable. Since the cash proceeds received were greater than the par value, this indicates that the bond was issued at a premium. Therefore, the difference would be recorded as a credit to Premium on Bonds Payable.

Question 13

A company has bonds outstanding with a par value of $100,000. The unamortized premium on these bonds is $2,700. If the company retired these bonds at a call price of 99, the gain or loss on this retirement is:
A) $1,000 gain.
B) $1,000 loss.
C) $2,700 loss.
D) $2,700 gain.
E) $3,700 gain.

Accepted Answer

The gain on retirement is calculated by comparing the net carrying amount of the bonds to the call price. The net carrying amount is the par value plus the unamortized premium, which is $100,000 + $2,700 = $102,700. The call price of 99 means the bonds are retired at 99% of their par value, which is $100,000 * 99% = $99,000. The gain is the difference between the net carrying amount and the retirement price, which is $102,700 - $99,000 = $3,700.

Question 14

Bonds that give the issuer an option of retiring them before they mature are:
A) Debentures.
B) Serial bonds.
C) Sinking fund bonds.
D) Registered bonds.
E) Callable bonds.

Accepted Answer

Callable bonds give the issuer the option to retire them before they mature, typically when interest rates have fallen, allowing the issuer to save money by issuing new bonds at a lower rate.

Question 15

A company has bonds outstanding with a par value of $100,000. The unamortized discount on these bonds is $4,500. The company retired these bonds by buying them on the open market at 97. What is the gain or loss on this retirement?
A) $0 gain or loss.
B) $1,500 gain.
C) $1,500 loss.
D) $3,000 gain.
E) $3,000 loss.

Accepted Answer

The carrying value of the bonds before retirement was:

$100,000 (par value) - $4,500 (unamortized discount) = $95,500

The company retired the bonds by buying them on the open market at 97% of par value, which is:

$100,000 x 97% = $97,000

The gain or loss on retirement is the difference between the carrying value and the amount paid to retire the bonds:

Gain/Loss = Amount Paid - Carrying Value
= $97,000 - $95,500
= $1,500 loss

Therefore, the correct answer is C, $1,500 loss.

Question 16

A discount on bonds payable:
A) Occurs when a company issues bonds with a contract rate less than the market rate.
B) Occurs when a company issues bonds with a contract rate more than the market rate.
C) Increases the Bond Payable account.
D) Decreases the total bond interest expense.
E) Is not allowed in many states to protect creditors.

Accepted Answer

A discount on bonds payable occurs when a company issues bonds with a contract rate less than the market rate. This means that the bonds are issued at a discount, or below face value, and the discount is amortized over the life of the bonds, resulting in a higher total interest expense.

Question 17

Adidas issued 10-year, 8% bonds with a par value of $200,000. Interest is paid semiannually. The market rate on the issue date was 7.5%. Adidas received $206,948 in cash proceeds. Which of the following statements is ?
A) Adidas must pay $200,000 at maturity and no interest payments.
B) Adidas must pay $206,948 at maturity and no interest payments.
C) Adidas must pay $200,000 at maturity plus 20 interest payments of $8,000 each.
D) Adidas must pay $206,948 at maturity plus 20 interest payments of $8,000 each.
E) Adidas must pay $200,000 at maturity plus 20 interest payments of $7,500 each.

Accepted Answer

Adidas must pay the par value of $200,000 at maturity. Since the bonds have a coupon rate of 8% and the par value is $200,000, the annual interest payment is $16,000. Given that interest is paid semiannually, there will be two payments of $8,000 each year for 10 years, totaling 20 payments of $8,000 each.

Question 18

On October 1, a $30,000, 6%, 3-year installment note payable is issued by a company. The note requires equal payments of principal plus accrued interest be paid at the end of each year on September 30. The present value of an annuity factor for 3 years at 6% is 2.6730. The payment will be:
A) $10,000.00.
B) $11,223.34.
C) $10,800.00.
D) $10,400.00.
E) $1,223.34.

Accepted Answer

The first step is to calculate the total amount payable over the 3 years using the present value of an annuity factor:

Total payment = Present value factor x Annual payment
Total payment = 2.6730 x Annual payment

The total payment needs to be equal to the amount borrowed, which is $30,000. So we can set the two equations equal to each other and solve for the annual payment:

2.6730 x Annual payment = $30,000
Annual payment = $30,000 / 2.6730
Annual payment = $11,223.34

Therefore, the annual payment is $11,223.34, which is option B.

Question 19

The market value of a bond is equal to:
A) The present value of all future cash payments provided by a bond.
B) The present value of all future interest payments provided by a bond.
C) The present value of the principal for an interest-bearing bond.
D) The future value of all future cash payments provided by a bond.
E) The future value of all future interest payments provided by a bond.

Accepted Answer

The market value of a bond is calculated by taking the present value of all future cash payments (both principal and interest) expected to be received from the bond. This is based on the time value of money concept that a dollar received in the future is worth less than a dollar received today. Therefore, the market value of a bond is the sum of the present values of all future cash payments.

Question 20

The Premium on Bonds Payable account is a(n):
A) Revenue account.
B) Adjunct or accretion liability account.
C) Contra revenue account.
D) Contra asset account.
E) Contra liability account.

Accepted Answer

Premium on Bonds Payable is an Adjunct or accretion liability account. It represents the excess of the price paid for a bond over its face value, which is amortized over the life of the bond.

Quiz 14: Long-Term Liabilities

When a bond sells at a premium:

A corporation borrowed $125,000 cash by signing a 5-year, 9% installment note requiring equal annual payments each December 31 of $32,136. What journal entry would the issuer record for the first payment?

A company issued 7%, 5-year bonds with a par value of $100,000. The market rate when the bonds were issued was 7.5%. The company received $97,947 cash for the bonds. Using the effective interest method, the amount of interest expense for the first semiannual interest period is:

A company issued 5-year, 7% bonds with a par value of $100,000. The market rate when the bonds were issued was 6.5%. The company received $101,137 cash for the bonds. Using the effective interest method, the amount of recorded interest expense for the first semiannual interest period is:

A bond sells at a discount when the:

A company retires its bonds at 105. The face value is $100,000 and the carrying amount of the bonds at the retirement date is $103,745. The issuer's journal entry to record the retirement will include a:

The effective interest amortization method:

A company may retire bonds by:

Amortizing a bond discount:

The Discount on Bonds Payable account is:

A company received cash proceeds of $206,948 on a bond issue with a par value of $200,000. The difference between par value and issue price for this bond is recorded as a:

A company has bonds outstanding with a par value of $100,000. The unamortized premium on these bonds is $2,700. If the company retired these bonds at a call price of 99, the gain or loss on this retirement is:

Bonds that give the issuer an option of retiring them before they mature are:

A company has bonds outstanding with a par value of $100,000. The unamortized discount on these bonds is $4,500. The company retired these bonds by buying them on the open market at 97. What is the gain or loss on this retirement?

A discount on bonds payable:

Adidas issued 10-year, 8% bonds with a par value of $200,000. Interest is paid semiannually. The market rate on the issue date was 7.5%. Adidas received $206,948 in cash proceeds. Which of the following statements is ?

On October 1, a $30,000, 6%, 3-year installment note payable is issued by a company. The note requires equal payments of principal plus accrued interest be paid at the end of each year on September 30. The present value of an annuity factor for 3 years at 6% is 2.6730. The payment will be:

The market value of a bond is equal to:

The Premium on Bonds Payable account is a(n) :