Question 1:PVB-0030Need a hint?See Reference...Webb Co. has outstanding a 7%, 10-year $100,000 face-value bond. The bond was originally sold to yield 6% annual interest. Webb uses the effective interest rate method to amortize bond premium. On June 30, year 1, the carrying amount of the outstanding bond was $105,000. What amount of unamortized premium on bond should Webb report in its June 30, year 2 balance sheet?$1,050$3,950$4,300$4,500This answer is correct.  Under the effective interest method, interest expense is computed as follows:

CA of  Yield

 Time   Interest

bonds×rate×

period

=expense

$105,000

×6% ×12/12

=$6,300

The cash interest payable is computed as follows:

FV of  Stated

 Time  Cash

bonds×rate ×

period

=interest

$100,000

×7% ×12/12

=$7,000

The bond premium amortization is the difference between these two amounts ($7,000 - $6,300 = $700). Therefore, the unamortized premium at 6/30/Y2 is $4,300 ($5,000 - $700).

Question 2:PVC-0006Need a hint?See Reference...Which of the following statements is true?All financial assets and financial liabilities must be valued at fair value.No financial assets or financial liabilities can be valued at fair value.Debt modifications may be valued at fair value.

Debt modifications must be valued at fair value.This answer is correct. An election can be made to value certain financial assets or financial liabilities at fair value. Modification of debt is eligible for such valuation. However, the fair value election is not a requirement.

Question 3:PVB-0053Need a hint?See Reference...Ray Finance, Inc. issued a 10-year, $100,000, 9% note on January 1, year 1. The note was issued to yield 10% for proceeds of $93,770. Ray did not elect the fair value option to report financial liabilities. Interest is payable semiannually. The note is callable after 2 years at a price of $96,000. Due to a decline in the market rate to 8%, Ray retired the note on December 31, year 6. On that date, the carrying amount of the note was $94,582, and the discounted market rate was $105,280. What amount should Ray report as gain (loss) from retirement of the note for the year ended December 31, year 6?$ 9,280$ 4,000$(2,230)$(1,418)This answer is correct.  The gain (loss) from retirement of debt is the difference between the cash paid to retire the debt ($96,000) and the debt’s carrying amount ($94,582).  The excess cash paid ($96,000 – $94,582 = $1,418) is recognized as a loss from retirement.

Loss 1,418  Notes payable

100,000  

 Disc. on NP

  5,418 (100,000 – 94,582)

 Cash   96,000

The original proceeds ($93,770) and the present value of the note discounted at the current market rate ($105,280) do not affect the computation of gain (loss) on retirement.

Question 4:PVC-0003Need a hint?See Reference...In year 1, May Corp. acquired land by paying $75,000 down and signing a note with a maturity value of $1,000,000. On the note’s due date, December 31, year 6, May owed $40,000 of accrued interest and $1,000,000 principal on the note.  May was in financial difficulty and was unable to make any payments. May and the bank agreed

to amend the note as follows:

 •The $40,000 of interest due on December 31, year 6, was forgiven. •The principal of the note was reduced from $1,000,000 to $950,000 and the maturity date extended 1 year to December 31, year 7.

 •May would be required to make one interest payment totaling $30,000 on December 31, year 7.

May does not elect the fair value option for reporting its financial liabilities.  As a result of the troubled debt restructuring, May should report a gain, before taxes, in its year 6 income statement of$40,000$50,000$60,000$90,000This answer is correct. In a troubled debt restructure involving modification of terms, the accounting depends on the relationship between the carrying amount (CA) of the debt (principal plus unpaid interest) and the total future payments (TFP). If the TFP are greater than the CA, the excess is recognized as future interest expense using a newly computed effective rate and no gain is recognized. If the CA is greater than the TFP, the excess is recognized as a gain, and no future interest expense is recognized. In this case, the CA ($1,000,000 principal + $40,000 accrued interest = $1,040,000) exceeds the TFP ($950,000 + 30,000 = $980,000), so the excess ($1,040,000 - $980,000 = $60,000) is recognized as a gain.

Question 5:PVA-0006Need a hint?See Reference...White Airlines sold a used jet aircraft to Brown Company for $800,000, accepting a 5-year 6% note for the entire amount. Brown’s incremental borrowing rate was 14%. The annual payment of principal and interest on the note was to be $189,930. The aircraft could have been sold at an established cash price of $651,460. The present value of an ordinary annuity of $1 at 8% for five periods is 3.99. The aircraft should be capitalized on Brown’s books at$651,460$757,820$800,000$949,650This answer is correct. Brown’s 14% incremental borrowing rate is significantly higher than the stated rate of 6%. Therefore, the stated rate is unreasonable and the acquisition should not be recorded at the face value ($800,000) of the note. The

cost of the aircraft is the present value of the note and stated interest payments discounted at 14% or the fair market value of the aircraft, whichever is more clearly evident. Since the aircraft has an established cash price of $651,460, this amount is an appropriate basis for recording the transaction.

Question 6:PVB-0014Need a hint?See Reference...A company issues bonds at 98, with a maturity value of $50,000. The entry the company uses to record the original issue should include which of the following?A debit to bond discount of $1,000.A credit to bonds payable of $49,000.A credit to bond premium of $1,000.A debit to bonds payable of $50,000.This answer is correct. The journal entry required to record the bond issued at a discount is

Cash 49,000

 

Discount on bond payable

1,000 

 Bonds payable   50,000

Question 7:PVB-0009Need a hint?See Reference...Album Co. issued ten-year $200,000 debenture bonds on January 2. The bonds pay interest semiannually. Album uses the effective interest method to amortize bond premiums and discounts. The carrying value of the bonds on January 2 was $185,953. A journal entry was recorded for the first interest payment on June 30, debiting interest expense for $13,016 and crediting cash for $12,000. What is the annual stated interest rate for the debenture bonds?6%7%12%14%This answer is correct. The requirement is to determine the stated interest rate for the debenture bonds. This answer is correct because the stated interest rate is equal to 12%, which is calculated by dividing two six-month interest payments by the face value of the debentures: 12% = ($12,000 + $12,000) ÷ $200,000.

Question 8:PVB-0036Need a hint?See Reference...A company issued a bond with a stated rate of interest that is less than the effective interest rate on the date of issuance. The bond was issued on one of the interest payment dates. What should the company report on the first interest payment date?An interest expense that is less than the cash payment made to bondholders.An interest expense that is greater than the cash payment made to bondholders.A debit to the unamortized bond discount.A debit to the unamortized bond premium.This answer is correct. Since the effective rate is higher than the coupon rate, the effective interest will be greater than the cash paid to the bondholders. If the stated rate of interest on a bond is less than the effective rate, the bond will sell at a discount. The interest paid is the coupon rate times the maturity value of the bond. The effective interest is the effective interest rate times the carrying value of the bond.

Question 9:PVB-0002Need a hint?See Reference...What type of bonds in a particular bond issuance will not all mature on the same date?Debenture bonds.Serial bonds.Term bonds.Sinking fund bonds.This answer is correct. The requirement is to identify the type of bond issue that will not all mature on the same date. This answer is correct because a bond issue that matures in installments at various dates is referred to as a serial bond.

Question 10:PVC-0004Need a hint?See Reference...On December 31, year 2, Marsh Company entered into a debt restructuring agreement with Saxe Company, which was experiencing financial difficulties.  Marsh restructured a $100,000 note receivable as follows:

•Reduced the principal obligation to $70,000.•Forgave $12,000 of accrued interest.•Extended the maturity date from December 31, year 2 to December 31, year 4.

•Reduced the interest rate from 12% to 8%.  Interest was payable annually on December 31, year 3 and year 4.

Present value factors

 Single sum, 2 years @ 8% .85734 Single sum, 2 years @ 12%

.79719

 Ordinary annuity 2 years @ 8%

1.78326

 Ordinary annuity 2 years @ 12%

1.69005

Marsh does not elect the fair value option for recording this note receivable.  In accordance with the agreement, Saxe made payments to Marsh on December 31, year 3 and year 4. How much interest income should Marsh report for the year ended December 31, year 4?$0$ 5,600$ 8,100$11,200This answer is correct. The requirement is to determine the amount of interest revenue to be recorded by Marsh, after a modification of terms type of troubled debt restructure on December 31, year 4. Under ASC Subtopic 310-40, when a modification of terms results in the present value of future cash flows being less than the carrying amount, then the interest revenue is calculated by using the effective interest method.  In this problem the expected future cash flows is determined by discounting the principal and interest at the original effective rate of 12%.

70,000x

.79719=55,803

5,600x

1.69005=  9,46 4

Present value of future cash flows

 65,267

The interest revenue to be recognized can then be determined using the effective interest method.

PV at 12/31/Y2   $65,267

Interest income at 12/31/Y3 ($65,267 x 12%)

$7,832

 

Interest receivable at 12/31/Y3 (70,000 x 8%)

5,600  

Increase in carrying value of loan     2,232 PV at 12/31/Y3   67,49

9Interest revenue at 12/31/Y4 (67,499 x 12%)

$8,100

 

Question 11:PVB-0057Need a hint?See Reference...Witt Corp. has outstanding at December 31, year 1, two long-term borrowings with annual sinking fund requirements and maturities as follows:

 

Sinking fundrequirements

Maturities

year 1

$1,000,000

$    --

year 2

  1,500,000

  2,000,000

year 3

  1,500,000

  2,000,000

year 4

  2,000,000

  2,500,000

year 5

  2,000,000

  3,000,000

  $8,000,000

$9,500,000

In the notes to its December 31, year 1 balance sheet, how should Witt report the above data?No disclosure is required.Only sinking fund payments totaling $8,000,000 for the next 5 years detailed by year need be disclosed.Only maturities totaling $9,500,000 for the next 5 years detailed by year need to be disclosed.The combined aggregate of $17,500,000 of maturities and sinking fund requirements detailed by year should be disclosed.This answer is correct. ASC Topic 440 requires disclosure at the balance sheet date of future payments for sinking fund requirements and maturity amounts of long-term debt during each of the next 5 years. Therefore, the combined aggregate of $17,500,000 of maturities and sinking fund requirements detailed by year should be disclosed.

Question 12:

PVC-0005Need a hint?See Reference...Ace Corp. entered into a troubled debt restructuring agreement with National Bank. National agreed to accept land with a carrying amount of $75,000 and a fair value of $100,000 in exchange for a note with a carrying amount of $150,000. Disregarding income taxes, what amount should Ace report as a gain on restructuring the debt?$0$25,000$50,000$75,000This answer is correct. The gain on restructuring the debt would be the difference between the carrying amount of the note received and the FMV of the land given.  The amount that Ace should report as gain in its income statement is

$150,000

      CV of note

– 100,000

      FMV of land

$ 50,000

      Gain on restructuring the debt

Question 13:PVB-0055Need a hint?See Reference...In open market transactions, Oak Corp. simultaneously sold its long-term investment in Maple Corp. bonds and purchased its own outstanding bonds. The broker remitted the net cash from the two transactions. Oak’s gain on the purchase of its own bonds exceeded its loss on the sale of Maple’s bonds. Oak should report theNet effect of the two transactions as an extraordinary gain.Effect of its own bond transactions as a gain in income before extraordinary items and report the Maple bond transaction as a loss in income before extraordinary items.Effect of its own bond transaction gain in income before extraordinary items, and report the Maple bond transaction as an extraordinary loss.Effect of its own bond transaction as an extraordinary gain, and report the Maple bond transaction loss in income before extraordinary items.This answer is correct. Both of the items are now treated as ordinary gains and losses.

Question 14:PVC-0002Need a hint?

See Reference...E & S Partnership purchased land for $500,000 on May 1, year 1, paying $100,000 cash and giving a $400,000 note payable to Big State Bank. E & S made three annual payments on the note totaling $179,000, which included interest of $89,000. E & S then defaulted on the note. Title to the land was transferred by E & S to Big State, which cancelled the note, releasing the partnership from further liability. At the time of the default, the fair value of the land approximated the note balance. In E & S’s year 4 income statement, the amount of the loss should be$279,000$221,000$190,000$100,000This answer is correct. On 5/1/Y1 E & S recorded the land purchased at a cost of $500,000.

Land 500,000

 

      Cash   100,000

      Note payable

  400,000

The three payments made would result in debits to note payable totaling $90,000 ($179,000 payments – $89,000 interest), bringing the balance in that account down to $310,000 ($400,000 – $90,000). Since the land transferred to settle the debt had a fair value of approximately $310,000, there is no gain on restructure.  There is, however, a loss on transfer of land of $190,000, since the FV of the land is less than its carrying amount ($500,000 – $310,000).

Loss on transfer of land

190,000

 

Note payable 310,000

 

      Land   500,000

Question 15:PVB-0012Need a hint?See Reference...On March 1, year 1, Cain Corp. issued at 103 plus accrued interest 200 of its 9%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. Cain paid bond issue costs of $10,000. Cain should realize net cash receipts from the bond issuance of$216,00

0$209,000$206,000$199,000This answer is correct.  To determine the net cash received from the bond issuance, the solutions approach is to prepare the journal entry for the issuance.

Cash ?  Bond issue costs 10,00

0 

 Premium on bonds payable

  6,000

 Bonds payable   200,000

 Interest expense   3,000

The bonds were issued at 103 ($200,000 x 1.03 = $206,000), so the premium is $6,000 ($206,000 – $200,000). The accrued interest covers the 2 months from 1/1 to 3/1 ($200,000 x 9% x 2/12 = $3,000).  The net cash received includes the $206,000 for the bonds and the $3,000 for the accrued interest, less the $10,000 paid for bond issue costs ($206,000 + $3,000 – $10,000 = $199,000).

Question 16:PVB-0008Need a hint?See Reference...When the interest payment dates of a bond are May 1 and November 1, and the bond is issued on June 1, year 1, the amount of interest expense for the year ended December 31, year 1, would be for2 months.6 months.7 months.8 months.This answer is correct. The amount of the interest expense would be determined by using the time period from the date of the issuance of the bonds to the end of the year. The calculation of interest expense is not dependent on interest payment dates but rather on the length of time the bonds are outstanding. This answer is correct because interest expense would be incurred for the period from June 1, year 1, to December 31, year 1, or seven months.

Question 17:PVB-0026

Need a hint?See Reference...On January 1, year 1, Jaffe Corporation issued at 95 five hundred of its 9%, $1,000 bonds. Interest is payable semiannually on July 1 and January 1, and the bonds mature on January 1, year 11. Jaffe paid bond issue costs of $20,000 which are appropriately recorded as a deferred charge. Jaffe uses the straight-line method of amortizing bond discount and bond issue costs. Assume Jaffe does not elect the fair value option for reporting financial liabilities. On Jaffe’s December 31, year 1 balance sheet, the bonds payable should be reported at their carrying value of$459,500$477,500$495,500$522,500This answer is correct. The carrying value of the bonds is their face amount ($500,000) less the unamortized discount. Since the bonds were issued at $475,000 ($500,000 x .95) the original discount was $25,000. Using the straight-line method of amortization, 1/10 of the discount would be amortized during the first year (1/10 x $25,000 = $2,500). Therefore, the unamortized discount at 12/31/Y1 is $22,500 ($25,000 — $2,500), and the carrying value is $477,500 ($500,000 — $22,500). The bond issue costs of $20,000 can be disregarded, since these are appropriately recorded as a deferred charge and reported in the asset section of the balance sheet.

Question 18:PVB-0029Need a hint?See Reference...On January 1, year 1, Korn Co. sold to Kay Corp. $400,000 of its 10% bonds for $354,118 to yield 12%. Interest is payable semiannually on January 1 and July 1. What amount should Korn report as interest expense for the 6 months ended June 30, year 1?$17,706$20,000$21,247$24,000This answer is correct.  Under the interest method, interest expense is computed as follows:

BV of ×Yield

×Time =Interest

bonds   rate perio expen

d se$354,118

×12%

×6/12 =$21,247

The interest payable on 6/30/Y1 is $20,000 ($400,000 × 10% × 6/12), so the 6/30/Y1 journal entry is

Interest expense

21,247

 

 Interest payable

  20,000

 Discount on BP

  1,247

Question 19:PVB-0020Need a hint?See Reference...How would the amortization of discount on bonds payable affect each of the following?

Carrying value of bond

Net income

Increase DecreaseIncrease IncreaseDecrease DecreaseDecrease IncreaseThis answer is correct. The solutions approach is to make the entry necessary to record the amortization of the discount.

Interest expense xxx

 Discount on bonds payable

xxx

Recall that the discount on bonds payable account usually carries a debit balance that reduces the carrying value of the bonds. This answer is correct because the credit to the discount account increases the carrying value of the bond, and the debit to interest expense will decrease net income.

Question 20:PVB-0010Need a hint?See Reference...During year 1 Cain Corporation incurred the following costs in connection with the issuance of bonds:

Printing and engraving $  15,000

Legal fees 80,000

Fees paid to independent accountants for registration information

10,000

Commissions paid to underwriter 150,000

What amount should be recorded as a deferred charge to be amortized over the term of the bonds?$ 15,000$150,000$245,000$255,000This answer is correct. Per ASC 835-30-45-3, engraving and printing costs, legal and accounting fees, commissions, promotion costs, and other similar costs should be debited to a deferred charge account and amortized over the term of the bonds. All of the costs given fall into one of these categories, so a total of $255,000 ($15,000 + $80,000 + $10,000 + $150,000) should be recorded as a deferred charge (bond issue costs).

Question 21:PVB-0028Need a hint?See Reference...On January 1, year 1, Gilson Corporation issued for $1,030,000, 1,000 of its 9%, $1,000 callable bonds. The bonds are dated January 1, year 1, and mature on December 31, year 14. Interest is payable semiannually on January 1 and July 1. The bonds can be called by the issuer at 102 on any interest payment date after December 31, year 5. The unamortized bond premium was $14,000 at December 31, year 6, and the market price of the bonds was 99 on this date. Gilson does not elect the fair value option for reporting financial liabilities. In its December 31, year 6 balance sheet, at what amount should Gilson report the carrying value of the bonds?$1,020,000$1,016,000$1,014,000$ 990,000This answer is correct. The carrying amount of the liability is the face amount of the bonds ($1,000,000) plus the unamortized bond premium ($14,000), or $1,014,000. The call provision (102), while disclosed, does not affect the carrying amount. The market price of the bonds (99) is neither disclosed nor used to compute the carrying amount.

Question 22:PVB-0024Need a hint?See Reference...On June 1 of the current year, Cross Corp. issued $300,000 of 8% bonds payable at par with interest payment dates of April 1 and October 1. In its income statement for the current year ended December 31, what amount of interest expense should Cross report?$ 6,000$ 8,000$12,000$14,000This answer is correct. The requirement is to determine the amount of interest expense that should be reported. This answer is correct because seven months of interest should be accrued, or $14,000 = ($300,000 × 8% × 7/12).

Question 23:PVB-0027Need a hint?See Reference...On January 1, year 1, Hansen, Inc. issued for $939,000, 1,000 of its 9%, $1,000 bonds. The bonds were issued to yield 10%. The bonds are dated January 1, year 1, and mature on December 31, year 10. Interest is payable annually on December 31. Hansen uses the interest method of amortizing bond discount. In its December 31, year 1 balance sheet, Hansen should report unamortized bond discount of$57,100$54,900$51,610$51,000This answer is correct. The solutions approach is to prepare the 12/31/Y1 interest entry.

Interest expense 93,900  

 Cash   90,000

 Discount on bonds payable

  3,900

Using the interest method, interest expense is the book (carrying) value of the bonds outstanding during the year ($939,000) times the yield rate of 10%.  The cash interest paid was the face amount of the bonds ($1,000,000) times the stated

rate of 9%. The difference of $3,900 is the bond discount amortization.  Since the original discount was $61,000 ($1,000,000 less $939,000), the unamortized discount at 12/31/Y1 is $57,100 ($61,000 less $3,900).

Question 24:PVC-0001Need a hint?See Reference...For a troubled debt restructuring involving only modification of terms, it is appropriate for a debtor to recognize a gain when the carrying amount of the debtExceeds the total future cash payments specified by the new terms.Is less than the total future cash payments specified by the new terms.Exceeds the present value specified by the new terms.Is less than the present value specified by the new terms.This answer is correct. ASC Topic 470 states that the debtor records a gain at the date of a restructure involving only a modification of terms when the prerestructure carrying amount exceeds the total future cash flows per the modification. The gain recognized is the difference between the prerestructure carrying amount and the future cash flows.

Question 25:PVB-0018Need a hint?See Reference...On March 1, year 1, Williams Corporation issued at 103 plus accrued interest, 100 of its 9%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. Williams paid bond issue costs of $5,000. Based on the information above, Williams would realize net cash receipts from the bond issuance of$ 98,000$ 99,500$103,000$104,500This answer is correct. $100,000 of bonds are issued at 103 plus accrued interest (2 months, from January 1 to March 1) less bond issue costs of $5,000. The cash received for the bonds is 103% of $100,000, or $103,000. The cash received for the accrued interest is $1,500 ($100,000 x 9% x 2/12). Therefore, cash receipts total $99,500 ($103,000 + $1,500 – $5,000).

Question 26:PVB-0013Need a hint?

See Reference...On March 1, year 1, Harbour Corporation issued 10% debentures dated January 1, year 1, in the face amount of $1,000,000, with interest payable on January 1 and July 1. The debentures were sold at par and accrued interest. How much should Harbour debit to cash on March 1, year 1?$ 966,667$ 983,333$1,016,667$1,033,333This answer is correct.  The amount of cash received is equal to the selling price of the bond plus accrued interest if the bond is issued between interest dates.

Sales price (bonds were sold at par) $1,000,000

Accrued interest for 2 months ($1,000,000 x 10% x 2/12)

    16,667

  $1,016,667

Question 27:PVA-0011Need a hint?See Reference...On October 1, year 1, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, year 1. Fleur’s year 1 financial statements reported interest payable and interest expense on the note for 3 months at 16%. All amounts due on the note were paid February 1, year 2. Fleur’s year 1 cost of goods sold for the holiday merchandise wasOverstated by the difference between the note’s face amount and the note’s October 1, year 1 present value.Overstated by the difference between the note’s face amount and the note’s October 1, year 1 present value plus 11% interest for 2 months.Understated by the difference between the note’s face amount and the note’s October 1, year 1 present value.Understated by the difference between the note’s face amount and the note’s October 1, year 1 present value plus 16% interest for 2 months.This answer is correct. Per ASC Topic 835, when a note is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless (1) interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash price of the property, goods, or services is materially different from the market value of the note. In these circumstances, the note and the cost of the property, goods, or services should be recorded at the fair value of the property, goods, or services or

the market value of the note, whichever is more clearly determinable. The note signed by Fleur bears an unreasonable interest rate of 16% as compared to the market rate of 11%.

If the note payable had been for more than 1 year, the correct entry would have recorded the inventory at the market value of the note, since at the time of the transaction there was no direct method of pricing the merchandise. A premium on the note payable would have been recorded (since the stated rate was greater than the market rate) and the premium would have been subsequently amortized over the term of the note payable.

However, since the term of the note is less than 1 year (4 months), Fleur’s recording of the inventory purchase and the note payable at the face amount of the note is appropriate accounting treatment per ASC Topic 835.

Because the entry records inventory at the face amount of the note rather than at its present value, and the inventory was all sold prior to December 31, year 1, cost of goods sold would already be recorded appropriately.  However, since that is not an option for the solution, the best answer would be that the cost of goods sold would be understated by the difference between the face value of the note and the present value of the note. (If the market rate of 11% had been used to value the note, the purchases would have been recorded at a higher amount.)

Question 28:PVB-0011Need a hint?See Reference...A company issued 10-year term bonds at a discount in year 1. Bond issue costs were incurred at that time. The company uses the effective interest method to amortize bond issue costs. Reporting the bond issue costs as a deferred charge would result inMore of a reduction in net income in year 2 than reporting the bond issue costs as a reduction of the related debt liability.The same reduction in net income in year 2 as reporting the bond issue costs as a reduction of the related debt liability.Less of a reduction in net income in year 2 than reporting the bond issue costs as a reduction of the related debt liability.No reduction in net income in year 2.This answer is correct. When bonds are issued, the issuing company often incurs printing costs, legal fees, commissions, and other similar expenses. Per ASC 835-30-45-3, bond issue costs are debited to a deferred charge account and amortized similarly to the bond discount. The amortization expense related to the bond issue costs is the same regardless of how the bond issue costs are reported on the balance sheet (i.e., as a deferred charge or as a reduction of the liability).

Question 29:PVB-0054Need a hint?See Reference...

A 15-year bond was issued in year 1 at a discount. The fair value option was not elected to value financial liabilities. During year 10 a 10-year bond was issued at face amount with the proceeds used to retire the 15-year bond at its face amount. The net effect of the year 10 bond transactions was to increase long-term liabilities by the excess of the 10-year bond’s face amount over the 15-year bonds.Face amount.Carrying amount.Face amount less the deferred loss on bond retirement.Carrying amount less the deferred loss on bond retirement.This answer is correct.  The following entries would be made to record the new bond issuance and the retirement of the old issuance:

Cash xxx

 

 Bonds payable (10-yr) 

xxx

Bonds payable (15-yr) xxx

 

Loss on early retirement

xxx

 

 Unamort. disc. on bonds pay.

  xxx

 Cash   xxx

Long-term liabilities would therefore be increased by the excess of the 10-year bond’s face amount over the 15 year bond’s carrying amount (bonds payable less unamortized discount).  Note that the loss is not deferred.

Question 30:PVB-0019Need a hint?See Reference...An investor purchased a bond classified as a long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond is more than the

Cash paid to seller

Face amount of bond

No YesNo NoYes NoYes YesThis answer is correct. When a bond is purchased between interest dates at a discount, the amount of cash paid to the seller or issuer is equal to the face amount of the bond, plus interest accrued since the last interest payment date, less the amount of the discount. The following entry would be made on the books of the

purchaser:

Investment in bonds (net)          

xxx

Accrued interest xxx

      Cash xxx

On the purchase date, the carrying value of the bonds is less than both the cash paid and the face value of the bonds.

Question 31:PVA-0012Need a hint?See Reference...On October 1, year 1, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, year 1. Fleur’s year 1 financial statements reported interest payable and interest expense on the note for 3 months at 16%. All amounts due on the note were paid February 1, year 2. As a result of Fleur’s accounting treatment of the note, interest, and merchandise, which of the following items was reported correctly?

12/31/Y1 retained earnings

12/31/Y1 interest payable

Yes YesNo NoYes NoNo YesThis answer is correct. The requirement is to determine whether Fleur’s retained earnings and interest payable were reported correctly in the year 1 financial statements. Since cost of goods sold was understated in year 1, not enough cost was deducted from sales, resulting in an overstatement of income and retained earnings. However, the interest expense for 3 months would also be misstated because it was calculated as 16% of the face value of the note rather than as 11% of the present value of the note. On February 1 when the note is paid these two effects will have offset each other. However, on December 31, year 1, retained earnings would be misstated. Interest payable was properly accrued at the 16% stated (cash) rate for the 3 months from the date the note was issued until year-end, resulting in the correct reporting of interest payable.

Question 32:PVB-0015Need a hint?See Reference...On January 1, a company issued a $50,000 face value, 8% five-year bond for $46,139 that will yield 10%. Interest is payable on June 30 and December 31. What is the bond carrying amount on December 31 of the current year?

$46,139$46,446$46,768$47,106This answer is correct. The requirement is to determine the bond carrying amount on December 31 of the current year. The carrying value of the bond can be calculated by completing an amortization table. The interest payment is calculated as the face amount of the bond times the coupon rate, adjusted for the number of payment periods per year, or $2,000 (50,000 × 4% interest for half the year). Interest expense is calculated as the effective rate of 5% times the beginning of the period carrying value.  Amortization of discount is the difference between the interest payment and interest expense. This answer is correct because the carrying value at December 31 of the current year is $46,768, as calculated below.

 

Date

Coupon payment 4%

Interestexpense 5%

Amortization ofdiscount

Discount onB/P

Carryingamount B/P

01-01

       --        --   $3,861 $46,139

06-30

$2,000 $2,307 $307 $3,554 $46,446

12-31

$2,000 $2,322 $322 $3,232 $46,768

Question 33:AICPA.101132FAROn September 30, World Co. borrowed $1,000,000 on a 9% note payable. World paid the first of four quarterly payments of $264,200 when due on December 30. In its December 31, balance sheet, what amount should World report as note payable? $735,800$750,000$758,300$825,800The first payment included interest of $22,500 (.09 x .25 x $1,000,000). Note that interest rates are always expressed for an annual period. Only 25% of year elapsed from Sept. 30 to the end of the year. The rest of the payment ($241,700 = $264,200 - $22,500) is principal. The note payable balance at Dec. 31 therefore is $758,300 ($1,000,000 - $241,700).

Question 34:

PVB-0022Need a hint?See Reference...On March 1, year 1, Clark Co. issued bonds at a discount. Clark incorrectly used the straight-line method instead of the effective interest method to amortize the discount. How were the following amounts, as of December 31, year 1, affected by the error?

Bond carrying amount

Retained earnings

Overstated OverstatedUnderstated UnderstatedOverstated UnderstatedUnderstated OverstatedThis answer is correct. When a company uses the effective interest method to amortize a discount on bonds payable, interest expense (which is based on the carrying value of the bonds) is lower in earlier years when compared to interest expense under the straight-line method. Therefore, the straight-line method results in understated retained earnings. Since more interest expense is recorded under the straight-line method, amortization of the discount on bonds payable will be greater under the straight-line method when compared to the effective interest method. Higher amortization results in a lower unamortized discount and, therefore, the carrying value of the bonds using the straight-line method is overstated.

Question 35:PVB-0016Need a hint?See Reference...Foley Co. is preparing the electronic spreadsheet below to amortize the discount on its 10-year, 6%, $100,000 bonds payable. Bonds were issued on December 31 to yield 8%.  Interest is paid annually.  Foley uses the effective interest method to amortize bond discounts.

  A B C D E    Cash Intere

stDiscount Carryin

g1Year

paid expense

amortization

amount

21       $86,580

32 $6,000

     

Which formula should Foley use in cell E3 to calculate the bonds’ carrying amount at the end of year 2?E2 + D3.E2 – D3.E2 + C3.

E2 – C3.This answer is correct because the carrying amount of a bond is the previous year carrying amount plus the amortization of the discount for the period and therefore, E2 + D3 is the appropriate formula.

Question 36:PVB-0031Need a hint?See Reference...On December 31, year 1, Wall Corp. issued $100,000 maturity value, 10% bonds for $100,000 cash. The bonds are dated December 31, year 1, and mature on December 31, year 11. Interest will be paid semiannually on June 30 and December 31. In Wall’s September 30, year 2 balance sheet, the amount of accrued interest expense should be$ 2,500$ 5,000$ 7,500$10,000This answer is correct. The bonds payable ($100,000) pay interest semiannually on June 30 and December 31. At 9/30/Y2 the last interest date was 6/30/Y2 (3 months earlier). Therefore, Wall should report 3 months accrued interest, or $2,500 ($100,000 × 10% × 3/12 = $2,500) in its 9/30/Y2 balance sheet.

Question 37:AICPA.900540FAR-P1-FAOn January 1, 2000, Fox Corp. issued 1,000 of its 10%, $1,000 bonds for $1,040,000. These bonds were to mature on January 1, 2010 but were callable at 101 any time after December 31, 2003. Interest was payable semi-annually on July 1 and January 1. On July 1, 2005, Fox called all of the bonds and retired them. The bond premium was amortized on a straight-line basis. Before income taxes, Fox's gain or loss in 2005 on this early extinguishment of debt was$30,000 gain.$12,000 gain.$10,000 loss.$8,000 gainThe portion of the bond term that remains is 4 1/2 years as of July 1, 2005, because the bonds have been outstanding for 5 1/2 years as of that date. Therefore, the book value of the bonds on July 1, 2005 equals the face value of the bonds ($1,000,000) plus the unamortized bond premium of $18,000 = (4.5/10)$40,000, for a total of $1,018,000. The gain on the bond extinguishment is the difference

between the book value and the amount paid to extinguish the bonds: $1,018,000 - 1.01($1,000,000) = $8,000. The gain results because it cost Fox less to retire the bonds than the book value of the bonds.

Question 38:PVB-0017Need a hint?See Reference...On April 1, year 1, Girard Corporation issued at 98 plus accrued interest, 200 of its 10%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. From the bond issuance Girard would realize net cash receipts of$191,000$196,000$198,500$201,000This answer is correct. $200,000 of bonds are issued at 98 plus accrued interest (3 months, from January 1 to April 1). The cash received for the bonds is 98% of $200,000, or $196,000. The cash received for the accrued interest is $5,000 ($200,000 x 10% x 3/12). Therefore, cash receipts total $201,000 ($196,000 + $5,000).

Question 39:PVB-0023Need a hint?See Reference...A bond issued on June 1, year 1, has interest payment dates of April 1 and October 1. Bond interest expense for the year ended December 31, year 1, would be for a period of3 months.4 months.6 months.7 months.This answer is correct because interest expense would be incurred for the period from June 1, year 1, to December 31, year 1, or 7 months. The amount of interest expense for a year is determined by using the time period from the date of the issuance of the bonds to the end of the year. Since purchasers would have paid the issuer for any accrued interest at the time of purchase (June 1), the bondholders do not actually receive a full interest payment on October 1; the net amount represents interest earned since the purchase date. Therefore, the calculation of

interest expense is not dependent on interest payment dates, but rather on the length of time the bonds are outstanding.

Question 40:PVB-0001Need a hint?See Reference...Bonds payable issued with scheduled maturities at various dates are called

Serial bonds

Term bonds

No YesNo NoYes NoYes YesThis answer is correct. Serial bonds are bond issues that mature in installments (i.e., on the same date each year over a period of years). Term bonds, on the other hand, are bond issues that mature on a single date.

Question 41:PVB-0003Need a hint?See Reference...Glen Corporation had the following long-term debt:

Sinking fund bonds, maturing in installments

$1,100,000

Industrial revenue bonds, maturing in installments

900,000

Subordinated bonds, maturing on a single date

1,500,000

The total of the serial bonds amounted to$1,500,000$2,000,000$2,400,000$3,500,000This answer is correct. Serial bonds are bond issues that mature in installments. Therefore, the total of the serial bonds is $2,000,000 ($1,100,000 + $900,000). The bonds which mature on a single date ($1,500,000) are called term bonds.

Question 42:PVB-0007Need a hint?See Reference...

An investor purchased a bond classified as a long-term investment between interest dates at a premium. At the purchase date, the carrying value of the bond is more than the

Cash paid to seller

Face value of bond

Yes YesYes NoNo YesNo NoThis answer is correct. The solutions approach is used to prepare the appropriate journal entry

Investment in bonds xxx

 

      Interest receivable (or revenue)

  xxx

      Cash   xxx

The Investment in bonds account is debited for the market value of the bond (price paid to seller) while the interest receivable account is debited for the amount of interest accrued from the previous interest payment date to the purchase date. The cash paid is the sum of the bond’s market value plus the accrued interest. Thus, the carrying value, which is represented by the amount in the investment account, is not greater than the cash paid. The fact that the bond was purchased at a premium, by definition, means that the market value (i.e., carrying value) is greater than the face value of the bond.

Question 43:PVB-0051Need a hint?See Reference...On June 30, year 1, Dean Company had outstanding 8%, $1,000,000 face value, 15-year bonds maturing on June 30, year 11. Interest is payable on June 30 and December 31. The unamortized balances on June 30, year 1, in the bond discount and deferred bond issue costs accounts were $45,000 and $15,000, respectively. Dean reacquired all of these bonds at 93 on June 30, year 1, and retired them. How much gain should Dean report on this early extinguishment of debt?$10,000$25,000$40,000$70,000This answer is correct.  When the bonds are retired, the bonds payable, the unamortized discount, and the unamortized bond issue costs must be taken off the books.  Cash is credited for the amount paid (93% x $1,000,000 = $930,000), and

the difference is the gain or loss on retirement.

Bonds payable

1,000,000  

 Bond discount

 45,000

 Bond issue costs

  15,000

 Cash   930,000

 Gain   10,000

The gain can also be computed as follows:

Net carrying amount of bonds ($1,000,000 – $45,000 – $15,000)

$  940,000

Cash paid (93% x $1,000,000) (930,000)

Gain $   10,000

Question 44:PVB-0021Need a hint?See Reference...How would the amortization of premium on bonds payable affect each of the following?

Carrying value of bond

Net income

Increase DecreaseIncrease IncreaseDecrease DecreaseDecrease IncreaseThis answer is correct. When the premium on bonds payable is amortized, the following entry is made:

Premium on bonds payable

xxx

 Interest expense xxx

This entry has several effects. First, it reduces the amount of the premium. Because the carrying value of the bonds is the face value of the bonds plus the unamortized premium, amortization of the premium serves to reduce the carrying value. Second, amortization of the premium decreases interest expense, thus increasing net income.

Question 45:PVB-0006

Need a hint?See Reference...For a bond issue which sells for less than its par value, the market rate of interest isDependent on rate stated on the bond.Equal to rate stated on the bond.Less than rate stated on the bond.Higher than rate stated on the bond.This answer is correct. Bonds generally provide for periodic fixed interest payments at a stated rate of interest. At issuance, the market (yield) rate of interest for the particular bond may be above, the same as, or below the stated rate. When the market (yield) rate of interest is higher than the stated rate, the bond will sell for less than its par value (as in this case). By selling the bond for less, the effective interest rate will equal the market (yield) rate.

Question 46:PVB-0025Need a hint?See Reference...On January 1, year 2, Battle Corporation sold at 97 plus accrued interest 200 of its 8%, $1,000 bonds. The bonds are dated October 1, year 1, and mature on October 1, year 12. Interest is payable semiannually on April 1 and October 1. Accrued interest for the period October 1, year 1, to January 1, year 2 amounted to $4,000. As a result on January 1, year 2, Battle would record bonds payable, net of discount, at$190,000$194,000$196,000$198,000This answer is correct. Bonds payable sold at a discount should be recorded net of this discount. Battle would record the sale of these bonds at $194,000 (200 x $1,000 x .97). Note that this amount is not affected by accrued interest, which is reported separately as a current liability, interest payable.

Question 47:AICPA.931131FAR-P1-FAOn September 1, 2003, Brak Co. borrowed on a $1,350,000 note payable from the Federal Bank. The note bears interest at 12% and is payable in three equal annual principal payments of $450,000. On this date, the bank's prime rate was 11%. The first annual payment for interest and principal was made on September 1, 2004.

At December 31, 2004, what amount should Brak report as accrued interest payable?$54,000$49,500$36,000$33,000Although the question is not completely clear, interest is paid at the time each principal payment is made. Thus, on 9/1/04, after the principal payment of $450,000 (and interest as well) is made, the remaining note balance is $900,000 ($1,350,000 - $450,000). Note that only the principal payment reduces the note balance. Interest for four months to 12/31/04 is recorded in accrued interest payable: $36,000 ($900,000 x .12 x 1/3 year).

Question 48:PVB-0061Need a hint?See Reference...In year 1, Jeremy Corporation issued 1,000 of its 8% $1,000 bonds for $1,040,000. The bonds were due on December 1, year 11. Jeremy did not elect the fair value option for reporting financial liabilities. On October 1, year 7, as part of its normal financing management strategy, Jeremy Corporation redeemed the bonds at a time when the carrying value of the bonds was $50,000 more than the cash paid to retire the bonds. Jeremy should report the $50,000 gain asExtraordinary gain on early extinguishment of debt.Discontinued operation.Interest income from the bond.Other income.This answer is correct. Early extinguishments of debt are not routinely treated as extraordinary items. Therefore, Jeremy should record this as other income on the company’s income statement.