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MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) AB Company issued a $100,000, 10%, bond at $99. Therefore, the bond: 1) A)
sold at a premium because the $1,000 accrued interest is added to the $100,000 face
amount. B)
sold at a discount because the stated interest rate was lower than the market interest
rate. C) was sold at a premium because the stated interest rate was higher than the yield rate. D) was sold for $100,000 less $1,000 of accrued interest. Answer: B
Explanation: A) B) C) D) 2)
ER issued for $2,060,000, two thousand of its 9%, $1,000 callable bonds. The bonds are
dated January 1, 2019, and mature many years from now. Interest is payable
semi-annually on January 1 and July 1. The bonds can be called by the issuer at $102 on
any interest payment date after December 31, 2023. The unamortized bond premium was
$28,000 at December 31, 2021, and the market price of the bonds was $99 on this date.
In its December 31, 2021, balance sheet, at what amount should GC report the carrying
value of the bonds? 2) A) $2,032,000 B) $2,040,000 C) $1,980,000 D) $2,028,000 E) Cannot answer; the bond term is not given Answer: D
Explanation: A) B) C) D) E) 1
3) For bonds payable, the cash interest paid in each interest period is: 3) A) Different depending upon the date of sale. B)
The same amount regardless of whether the bond was sold at par, a discount, or a
premium. C) Dependent on the initial amount of accrued interest. D) Not the same amount when the stated and yield interest rates are different. Answer: B
Explanation: A) B) C) D) 4)
In-substance defeasance is sometimes used as a method of bond retirement. Choose the
correct statement about this practice. 4) A)
The firm may invest in any investment-grade debt security to retire the bonds as
long as the investment securities are transferred irrevocably to a trustee B) The bonds are legally retired as a result C)
Neither the assets used to effect the defeasance, nor the bonds themselves, are
reported in the balance sheet, even though the bonds remain outstanding D)
The process may require the company which issued the bonds to make substantial
payments in addition to the investments purchased for the defeasance Answer: C
Explanation: A) B) C) D) 5)
Bonds payable should be reported as a long-term liability in the balance sheet of the
issuer at: 5) A) Issue price, excluding any accrued interest at purchase date. B) Issue price less any unamortized bond premium or plus any unamortized discount. C) Issue price plus any unamortized bond premium or less any unamortized discount. D) Current market price. E) lower-of-cost-or-market. Answer: C
Explanation: A) B) C) D) E) 2
6) If a bond was sold at $108, the stated rate of interest was: 6) A) Equal to market rate. B) Lower than market rate. C) Not related to market rate. D) Higher than market rate. Answer: D
Explanation: A) B) C) D) 7) The rate of interest specified on the face of the debt is called the: 7) A) Stated interest rate. B) Effective interest rate. C) Yield interest rate. D) Market interest rate. Answer: A
Explanation: A) B) C) D) 8)
When the interest payment dates of a bond are May 31 and November 30, and a bond
issue is sold on July 1, the price of the bond will be: 8) A) Increased by accrued interest from May 31 to July 1. B) Unaffected by accrued interest. C) Decreased by accrued interest from May 31 to July 1. D) Increased by accrued interest from July 1 to November 30. E) Decreased by accrued interest from July 1 to November 30. Answer: B
Explanation: A) B) C) D) E) 9)
VB owes a $200,000, 8%, five-year note payable dated January 1, 2020. It is the end of
year 2020, and instead of making the interest payment now due, VB has made
arrangements to pay the debt and the 2020 interest payment in four equal instalments
based on the same interest rate. The first payment is to be made on January 1, 2021. The
amount of the equal annual payments is (rounded to the nearest dollar): 9) A) $60,384 B) $55,912 C) $54,000 D) $65,214 Answer: A
Explanation: A) B) C) D) 3
10)
There are two methods for amortizing premiums and discounts on the sale of bonds. The
differences between the two methods are: 10) A) There are no differences between the two methods. B)
Both methods charge a constant amount of interest to the financial statements each
year; however, the effective interest method charges a larger total amount of interest
expense over the life of the bond. C)
The effective interest method charges a different interest expense each year while
the straight-line method results in a constant amount of expense each year. D) None of these answers are correct. Answer: C
Explanation: A) B) C) D) 11)
If bonds are issued initially at a discount and the straight-line method of amortization is
used for the discount, interest expense in the early years will be: 11) A) less than the amount of the interest payments. B) The same as if the interest method is used. C) more than if the interest method is used. D) less than if the interest method is used. Answer: C
Explanation: A) B) C) D) 12)
On January 1, 2014, ER signed a $120,000, 10%, three-year, note payable. The proceeds
are to be used to purchase a computer and related software for the company. The lending
institution advanced proceeds of $115,800 and took a mortgage on the computer. The
note is payable in three equal annual instalments starting on December 31, 2014. The
effective interest rate to use for this debt is (rounded to the nearest percent; do not
interpolate): 12) A) 13%. B) 10%. C) 11%. D) 12%. Answer: D
Explanation: A) B) C) D) 4
13) Which of the following is true with respect to bond retirement? 13) A) On debt retirement all related accounts should be update. B)
Gains and losses on bond retirements may be classified as ordinary gains and losses
or unusual gains and losses. C)
If interest rates increase, the issuer can retire bonds at a gain by buying them on the
open market. D) All of these answers are correct. Answer: D
Explanation: A) B) C) D) 14)
$5,000 (face value) of bonds with a book value of $4,300 was retired 4 years and 9
months prior to maturity. The dollar amount (excluding interest) paid to retire the bonds
was $4,700. The entry to record the retirement would include: 14) A) dr. bonds payable $5,000 B) dr. bonds payable $4,700 C) cr. unusual gain $400 D) cr. cash $4,300 Answer: A
Explanation: A) B) C) D) 15) A firm retired a long-term note by in-substance defeasance. This means that: 15) A)
there is only a remote chance that the debtor will be required to make further
payments on the liability. B)
the debtor has been released of its legal responsibility for all remaining debt
payments. C)
the debt is shown as an offset against the assets used to retire the debt, in the
debtor’s balance sheet. D) the creditors have been paid. E)
the debtor will continue to recognize interest expense on the debt but will make no
more payments. Answer: A
Explanation: A) B) C) D) E) 5
16)
On November 1, 2009, WC purchased CX, 10-year, 7%, bonds with a face value of
$100,000 for $96,000. The bonds are intended to be held to maturity. An additional
$2,333 was paid for the accrued interest. Interest is payable semi-annually on January 1
and July 1. The bonds mature on July 1, 2016. WC uses the straight-line method of
amortization. Ignoring income taxes, the amount of interest revenue reported in WC’s
2019 income statement (year-end December 31) as a result of WC’s long-term bond
investment in CX was: 16) A) $1,267 B) $1,067 C) $1,120 D) $1,167 Answer: D
Explanation: A) B) C) D) 17) Which of the following statements is true? 17) A)
If a bond is sold “at a premium,” the effective interest rate on the bond is higher
than the stated interest rate. B)
If a bond is sold “at a discount,” the effective interest rate on the bond is lower than
the stated interest rate. C) Bond price of 98 means that the yield rate is 98% of the stated rate. D)
If a bond is sold between interest dates, it is necessary to record the interest accrued
since the last payment date before sale. Answer: D
Explanation: A) B) C) D) 18) ASPE and IFRS differ in their treatment of long-term Bonds Payable in that: 18) A) The straight-line method may be used under ASPE but not under IFRS. B)
Under IFRS, exchange gains and losses on short-term debt are recorded in the
income statement immediately. C) ASPE ignores foreign exchanges gains and losses. D) IFRS does not account for foreign exchange gains and losses on Bonds Payable. Answer: A
Explanation: A) B) C) D) 6
19)
The rate of interest used to discount the future cash payments on a debt to the cash
equivalent borrowed is least likely to be described by which of the following terms: 19) A) Effective interest rate. B) Stated interest rate. C) Yield interest rate. D) Prevailing interest rate. Answer: B
Explanation: A) B) C) D) 20)
On March 1, 2012, WC issued 10% stated interest rate, 10 year debentures dated January
1, 2012, in the face amount of $1,000,000, with interest payable on January 1 and July 1.
The debentures were sold to yield 8% plus accrued interest. How much should WC debit
to cash on March 1, 2012, if the bondholders receive their pro-rata share of coupon on
that date? 20) A) $1,152,573 B) $1,135,927 C) $903,003 D) $901,967 Answer: A
Explanation: A) B) C) D) 21)
AB sold its 10-year bond at a discount. In reporting the bonds and the related discount on
a balance sheet shortly thereafter, the discount should be: 21) A) Recorded as expense in the period of sale. B) Reported as a deferred charge. C) Deducted from the bonds payable. D) Added to the bonds. Answer: C
Explanation: A) B) C) D) 22)
When the interest payment dates of a bond are May 31 and November 30, and a bond
issue is sold on July 1, the amount of cash received by the issuer will be: 22) A) Unaffected by accrued interest. B) Decreased by accrued interest from July 1 to November 30. C) Increased by accrued interest from May 31 to July 1. D) Decreased by accrued interest from May 31 to July 1. E) Increased by accrued interest from July 1 to November 30. Answer: C
Explanation: A) B) C) D) E) 7
23)
On September 1, 2020, ER issued 11%, 10 year bonds dated June 1, 2020, in the face
amount of $140,000, with interest payable July 1 and December 31. The bonds were sold
for $140,000. How much should ER debit to cash on September 1, 2020? 23) A) $142,567 B) $140,000 C) $147,700 D) Cannot be determined from the information given Answer: A
Explanation: A) B) C) D) 24)
JMR bought 15 Z Corporation’s $1,000 bonds for $15,270 total, on April 1, 2014, (five
years prior to maturity). The bonds pay 8% semi-annual interest on April 1 and October
1. On December 31, 2014, the bonds had a market value of $14,950 (not a permanent
decline). JMR purchased these bonds at: 24) A) A discount. B) A premium. C) Par. D) Par plus accrued interest. E) A discount plus accrued interest. Answer: B
Explanation: A) B) C) D) E) 25)
Which of the following is not one of the conditions that must be met to qualify as
extinguishment of debt by in-substance defeasance? 25) A)
There is a reasonable possibility that the debtor will be called on to make additional
payments on the debt. B) Trust must own monetary assets that are essentially risk free. C)
Cash inflows into the trust must approximately coincide with required cash
outflows. D) The qualifying assets must not be used for trustee fees. Answer: A
Explanation: A) B) C) D) 8
26) Straight-line amortization of bond premium or discount: 26) A)
Provides the same total amount of interest expense and interest revenue as the
effective interest method over the life of the bonds. B) is appropriate for deep discount bonds. C)
Provides the same amounts of interest expense and interest revenue each interest
period as the effective interest method. D) is appropriate when the bond term is especially long. E) Can be used as an optional method of amortization in all situations. Answer: A
Explanation: A) B) C) D) E) 27)
R Company was indebted to A Inc. at January 1, 2014. The note called for a $25,000
payment to be made on December 31, 2014 and also on December 31, 2015. The note
was non-interest bearing yet 10% was the prevailing rate at the time the note was issued.
What is the book value of the note on R’s January 1, 2014 balance sheet (rounded)? 27) A) $50,000 B) $47,727 C) $47,500 D) $38,962 E) $43,388 Answer: E
Explanation: A) B) C) D) E) 28) All of the following are true with respect to sinking funds except: 28) A) A sinking fund may be handled by a trustee or by the individual company. B)
Once the sinking fund is established, the company has no more responsibility to the
debt. C) A sinking fund may make the investment more attractive to investors. D) A sinking fund is a cash fund that is restricted for retiring the debt of a company. Answer: B
Explanation: A) B) C) D) 9
29)
Bond A and Bond B both have a maturity value of $1,000 and pay annual interest of 9%.
The market rate of interest is also 9%. Bond A matures in 4 years and Bond B matures in
5 years. Which of the following is correct? 29) A) Both bonds sell for the same amount, $1,000. B) Bond A will sell for more than Bond B. C) Bond B will sell for more than Bond A. D) Both bonds sell for more than $1,000. E) There is not sufficient information to answer the question. Answer: A
Explanation: A) B) C) D) E) 30)
KR issued bonds payable with a face amount of $200,000 and a maturity date ten years
from date of issuance. If the bonds were issued at a premium, this indicated that: 30) A) The effective and stated rates of interest were the same. B) The stated rate of interest exceeded the effective rate of interest. C) The effective rate of interest exceeded the stated interest rate. D) The stated interest rate and the market interest rate were the same. E) No necessary relationship exists between the two rates. Answer: B
Explanation: A) B) C) D) E) 31)
The result of an effective interest rate that is higher than the stated rate on a debt security
is the: 31) A) Cash interest paid on each interest date will be changed. B)
Dollar amount of interest expense reported on the income statement, assuming the
interest method is used, will increase each interest period. C) Security will sell at a premium. D) Carrying value of the debt will decrease each interest period. Answer: B
Explanation: A) B) C) D) 10
32)
In theory (disregarding any other marketplace variables) the proceeds from the sale of a
bond will be equal to: 32) A)
The present value of the principal amount due at the end of the life of the bond plus
the present value of the interest payments made during the life of the bond, each
discounted at the prevailing market rate of interest. B) The sum of the face amount of the bond and the periodic interest payments. C)
The face amount of the bond plus the present value of the interest payments made
during the life of the bond discounted at the prevailing market rate of interest. D)
The present value of the principal amount due at the end of the life of the bond plus
the present value of the interest payments made during the life of the bond, each
discounted at the stated rate of interest. Answer: A
Explanation: A) B) C) D) 33) Gains or losses from the early extinguishment of debt, if material, should be: 33) A) amortized over the life of the new issue. B) recognized as an extraordinary item in the period of extinguishment. C) amortized over the remaining original life of the extinguished issue. D) recognized in income as ordinary gains and losses or as unusual items. Answer: D
Explanation: A) B) C) D) 34) Bonds payable (due 5 years from the balance sheet date) should be classified as follows: 34) A) A long-term liability. B) A contingent liability. C) An element of the owners’ equity. D) A current liability. Answer: A
Explanation: A) B) C) D) TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false. 35)
The carrying value of a bond from the issuing corporation’s standpoint will always move
closer to its face value, regardless of whether the bond is issued at a premium or a
discount. 35) Answer: True False Explanation: 11
36)
Use of the effective interest method for amortizing bond premiums and discounts is
mandatory under IFRS but not under ASPE. 36) Answer: True False Explanation: 37) Hedging is one method of minimizing foreign exchange risk. 37) Answer: True False Explanation: 38)
Interest may be recognized on a note even though the note does not explicitly state an
interest rate. 38) Answer: True False Explanation: 39) Borrowing costs can only be capitalized on non-financial assets. 39) Answer: True False Explanation: 40)
In-substance defeasance means that a debtor irrevocably places cash or other monetary
assets in a trust fund to pay interest on an outstanding debt. In such situations, the debt is
always recorded as paid when the trust fund is set up (i.e. removed from the books). 40) Answer: True False Explanation: 41) Transaction costs are deducted from the carrying value of long-term financial liabilities. 41) Answer: True False Explanation: 42)
Bonds are said to be redeemable when they can be prematurely retired at the discretion of
the issuing company and retractable when they can be prematurely retired at the
investor’s discretion. 42) Answer: True False Explanation: 43)
An increase in interest rates may make bond defeasance more attractive to the issuing
corporation. 43) Answer: True False Explanation: 44)
Under the effective interest method, interest expense is calculated by multiplying the
market interest rate by the carrying value of the bonds. 44) Answer: True False Explanation: 45) In-substance defeasance leads to the de-recognition of a company’s long-term debt. 45) Answer: True False Explanation: 12
46) Callable bonds are callable at the option of the investor. 46) Answer: True False Explanation: 47) The capitalization of borrowing costs is mandatory under both IFRS & ASPE. 47) Answer: True False Explanation: 48)
Assume that a company issues bonds at a discount. Under the effective interest method,
the company will record progressively less interest expense with the passage of time. 48) Answer: True False Explanation: 49) The principal amount of a debt is the cash or cash equivalent amount borrowed. 49) Answer: True False Explanation: 50)
A company issuing shares to comply with its debt covenants for cash would
simultaneously decrease (improve) its debt-to-assets and debt-to equity ratios. 50) Answer: True False Explanation: 51)
A company enters into a forward exchange contract to hedge its US dollar payable which
is due in 90 days. The company committed to purchase sufficient US currency to settle
its liability at a rate of $1 US=$1.20 CAD US. The company’s year-end falls 30 days
before the settlement date. On that date, the forward rate for 30-day settlement contracts
was 1 US=$1.22 CAD US. As a result of these facts the company will record a gain on
its current year financial statements. 51) Answer: True False Explanation: 52)
When the maturity date of a bond issue is within one year or the operating cycle
(whichever is longer) of the current balance sheet date, the bond liability should be
reclassified as a current liability (assuming the payment will be made out of current
assets). 52) Answer: True False Explanation: 53)
The amortization of a bind discount or premium over the life of a bond will be the same
under both the straight line and effective interest methods. 53) Answer: True False Explanation: 54)
When the market rate exceeds the stated or nominal rate, a bond’s carrying value will be
less than its fair value. 54) Answer: True False Explanation: 13
55)
A $1,000, 6%, 10-year bond purchased as a long-term investment at an effective rate at
7%, will pay the investor $70 cash interest each year. 55) Answer: True False Explanation: 56)
The stated rate of interest is the interest rate used to determine the amount of cash
interest that will be paid on the principal. 56) Answer: True False Explanation: 57)
A short-term payable may be the current portion of a long-term liability, which arises
when the next payment on such a debt will be made out of current assets. 57) Answer: True False Explanation: 58) Debt issue costs on long-term debt are expensed upon issue. 58) Answer: True False Explanation: 59)
The present value of any bond payable issued between interest-payment dates will
include any interest accrued since the last interest payment date. 59) Answer: True False Explanation: 60)
The cost of any equity financing is included when calculating the cost of generalized
borrowings. 60) Answer: True False Explanation: 14
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 61)
X owed a debt dated January 1, 2020, amounting to $91,330. Arrangements were made to pay the
debt in three equal annual instalments, starting on December 31, 2020. The interest is 15% per annum.
(a) Compute the amount of the annual cash payment to be made on each December 31.
Payment $ ________.
(b) Prepare the related debt amortization schedule for the term of the debt. Answer:
(a) $91,330 / (PVA, 15%, 3)(2.28323) = $40,000
(b)
Date Cash – Interest Expense
(15%) =
Principal
Reduction
Principal
Balance
Jan. 1/2000 $91,330
Dec. 31/2000 40,000 13,700 26,300 65,030
Dec. 31/2001 40,000 9,755 30,245 34,785
Dec. 31/2002 40,000 5,218 34,782*
________
*$3 difference due to rounding 62)
On March 1, 2002, the XYZ Company issued bonds dated January 2, 2002 with the following
characteristics:
Face value $20,000,000
Coupon rate 7.6%
Yield to maturity 8%
Coupon payment dates June 30, Dec. 31
Maturity 15 years
The XYZ Company’s year-end is December 31.
Required:
a. Assuming the XYZ Company uses the effective interest method,
i. Prepare all journal entries relating to this bond issue for the year 2002.
ii. Assume that on July 2, 2008; the company redeems one half of the bond issue on the open market
at 98. Prepare the journal entry on July 2, 2008.
b. Repeat the above requirements on the assumption the straight-line method is used. Answer:
N.B: The solution below does not use a separate discount account. The discount is deducted
directly from Bonds Payable. Students may also use a separate discount account as per the
examples in the text.
a. i. Proceeds received – N = 30, I = 4, PMT = 760,000, FV = 20,000,000
15
Answer:
Solve for PV = $19,308,319
Accrued interest = $760,000 2/6 = $253,333
Mar. 1, 2002
Cash $19,308,319
Bonds payable $19,308,319
Cash 253,333
Interest expense 253,333
June 30, 2002
Interest expense* 772,333
Bonds payable 12,333
Cash 760,000
* $19,308,319 4%
Dec. 31, 2002 Interest expense** 772,826
Bonds payable 12,826
Cash 760,000
** ($19,308,319 + 12,333) 4%
19,320,652 4%
ii. Book value of bonds on July 2, 2008 =
N = 17, I = 4, PMT = 760,000, FV = 20,000,000
Solve for PV = $19,513,373
Book value of bonds redeemed: $19,513,373 1⁄2 = $9,756,687
July 2, 2008
Bonds payable 9,756,687
Loss on redemption bonds 43,313
Cash 9,800,000
b. i. Mar. 1, 2002
Cash $19,308,319
Bonds payable $19,308,319
Cash 253,333
Interest expense 253,333
June 30, 2002
Interest expense 775,544
Bonds payable* 15,544
Cash 16
760,000
Answer: Cash 760,000
* Discount = $691,681
Monthly amortization = $691,681/178 months
= $3,886 four months = $15,544
Dec. 31, 2002 Interest expense 783,316
Bonds payable** 23,316
Cash 760,000
** $3,886 six months = $23,316
ii. Book value of bonds on July 2, 2008 =
= $20,000,000 – (3,886 102 months remaining)
= $20,000,000 – 396,372
= $19,603,628
Book value of bonds redeemed: $19,603,628 1⁄2 = $9,801,814
July 2, 2008
Bonds payable 9,801,814
Gain on redemption of bonds 1,814
Cash 9,800,000 63)
ABC Inc. borrowed funds from its bank. Details are as follows.
Four year term loan, U.S. $500,000
Funds borrowed 1 January 20X6; due 31 December 20X9
Exchange rates:
1 January 20X6 U.S. $1 = Cdn. $1.35
31 December 20X6 U.S. $1 = Cdn. $1.40
31 December 20X7 U.S. $1 = Cdn. $1.42
31 December 20X8 U.S. $1 = Cdn. $.136
31 December 20X9 U.S. $1 = Cdn. $1.39
Part A: Based on the above information prepare entries to record receipt of loan proceeds for January
20X6.
Part B: Based on the above information prepare entries to record the adjustment to spot rate for
December 20X6.
Part C: Based on the above information prepare entries to record adjustment to spot rate December
20X7
Part D: Based on the above information prepare entries to record adjustment to spot rate December
20X8
Part E: Based on the above information prepare entries to record adjustment to spot rate December
20X9
17
Part F: Based on the above information prepare entries to record repayment of loan December 20X9
Part G: Based on the above information calculate the total accounting recognition of
