ACCT II Ch 14 Bonds and Long-Term Notes

Which of the following statements is not true concerning types of bonds?

• A debenture bond is secured only by the “full faith and credit” of the issuing corporation

• A call feature on a callable (or redeemable) bond allows the issuer to buy back outstanding bonds at a price to be determined at the call date

• A mortgage bond is backed by a lien on a specified real estate owned by the issuer

• Coupon (or bearer) bonds require the holder to clip a coupon attached to the bond to redeem interest payments

Answer explanation

The call price must be pre-specified and often exceeds the bond’s face amount.

On June 30, 2021, Mabry Corporation issued $15 million of its 8% bonds for $13.8 million. The bonds were priced to yield 10%. The bonds are dated June 30, 2021. Interest is payable semiannually on December 31 and July 1. If the effective interest method is used, by how much should the bond discount be reduced for the 6 months ended December 31, 2021?

• 48,000

• 60,000

• 68,000

• 90,000

Answer explanation

Interest expense ($13,800,000 × .10 × 6/12)      690,000

  Discount (difference)                    90,000

  Cash ($15,000,000 × .08 × 6/12)             600,000

Chism Corporation issued $10 million face amount of bonds on January 1, 2021. The bonds have a 10-year term and pay interest semiannually. The following is a partial bond amortization schedule for the bonds.

 Payment  ash  Effective  Decrease in   Outstanding

  Interest   Balance  Balance

  11,487,747

1  400,000  344,632   55,368  11,432,379

2  400,000  342,971  57,029  11,375,350

  3  400,000  341,261  58,739  11,316,611

4  400,000 

What is the interest expense on the bonds in 2022?

• 119,241

• 342,961

• 680,759

• 800,000

Answer explanation

Semiannual effective rate = $344,632 ÷ $11,487,747 = 3%

Interest expense = $341,261 + ($11,316,611 × 3%) = $680,759

Kazali Industries purchased a machine from Keefe Corporation on October 1, 2021. In payment for the $432,000 purchase, Kazali issued a one-year installment note to be paid in equal monthly payments at the end of each month. The payments include interest at the rate of 12%. Monthly installment payments are:

• 36,000

• 37,335

• 38,004

• 38,383

Answer explanation

$432,000 (amount of loand 

÷ 11.25508  (PV of annuity)       

= $38,383 (payment)

   

In each subsequent cash payment on an installment note:

• The amount of principal paid decreases

• The amount of principal paid increases

• The amount of interest paid increases

• The amounts paid for both interest and principal increase proportionately

Answer explanation

Interest expense (effective rate times a declining balance)      xxx

Notes payable (difference)       xxx

  Cash (equal payment each period)    xxx

Vernois Company purchased a machine from Chunn Corporation on October 31, 2021. In payment for the $576,000 purchase, Vernois issued a one-year installment note to be paid in equal monthly payments of $51,176 at the end of each month. The payments include interest at the rate of 12%. The amount of interest expense that Vernois will report in its income statement for the year ended December 31, 2021, is:

• 5,118

• 5,760

• 11,066

• 11,520

Answer explanation

Interest expense (1% × outstanding balance)  5,760 Note payable (difference)  45,416      Cash (payment)  51,176

 

November (1% × $576,000)  $    5,760

December (1% × [$576,000 − $45,416])      5,306

  2021 interest expense  $11,066

Which of the following is true concerning financial statement disclosure for debt instruments?

• The fair value of financial instruments must be disclosed either in the body of the financial statements or in disclosure notes

• Disclosures should include the aggregate amounts payable for each of the next five years for any long-term borrowing

• Both the issuer and the investor report interest as an operating activity on the statement of cash flows

• All of the above

Answer explanation

Disclosures should include the fair value of financial instruments and the aggregate amounts payable for the next five years on long-term borrowing, while interest is reported as an operating activity on the statement of cash flows.

Enterprise Group issued $100,000 of 3-year, 6% bonds on December 31, 2022, for $106,000. Enterprise uses straight-line amortization. On May 1, 2023, $10,000 of the bonds were retired at 110. As a result of the retirement, Enterprise will report a:

• $400 loss

• $467 loss

• $1,100 loss

• $1,100 gain

Answer explanation

Interest expense (to balance)  133

Premium on bonds payable ([$6,000 × 1/3 × 4/12)] × 10% )  67 

     Interest payable ([$100,000 × 6% × 4/12 ] × 10%)  200

Bonds payable (book value)  10,553

Loss on early extinguishment (to balance)             467 

     Cash (call price)  11,000

Paid at redemption: $10,000 × 110% =  $11,000

Book value: [$106,000 − ($6,000 × 1/3 × 4/12)] × 10% =  10,533

Loss  $    467

Zimmern Foods has bonds outstanding during a year in which the general (risk-free) rate of interest has not changed. Zimmern elected the fair value option for the bonds upon issuance. What will Zimmern report for the bonds in its income statement for the year?

• Interest expense and a gain

• Interest expense and a loss

• A gain and no interest expense

• Interest expense and no gain or loss

Answer explanation

Because general interest rates did not change, we assume any change in the fair value is due to a change in credit risk, so any gain or loss would be reported as OCI, not part of net income.

Monk Investigations issued 11% bonds, dated January 1, with a face amount of $800,000 on January 1, 2022. The bonds sold for $740,000. For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Monk determines interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2022, the fair value of the bonds was $730,000, with $4,000 of the change due to a change in general interest rates. Monk’s statement of comprehensive income will include:

• A gain from change in the fair value of debt of $10,824

• A loss from change in the fair value of debt of $6,824

• A gain from change in the fair value of debt of $4,000

• A gain from change in the fair value of debt of $6,824

Answer explanation

Comprehensive income includes both net income and OCI.

Bonds payable   $800,000 Less: Discount  ($60,000 − 400 − 424)      59,176 Book value   $740,824   Gain–N/I  4,000    Gain–OCI           6,824  Fair value   

$730,000

Interest expense ($740,000 × 12% × 6/12) 44,400

  Discount on bonds payable  400

  Cash ($800,000 × 11% × 6/12)  44,000

Interest expense ([$740,000 + 400] × 12% × 6/12)   44,424

  Discount on bonds payable   424

  Cash ($800,000 × 11% × 6/12)  44,000