PVB-0030
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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?
$1,05
0
$3,95
0
$4,30
0
$4,50
0
This answer is correct. Under the effective interest method, interest expense is
computed as follows:
CA of
1,418
100,00
0
5,418 (100,000
94,582)
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-0003
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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 notes 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
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-0014
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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
Discount on bond
payable
Bonds payable
49,00
0
1,000
50,00
0
Question 7:
PVB-0009
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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
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%
Single sum, 2 years @
12%
Ordinary annuity 2 years
@ 8%
Ordinary annuity 2 years
@ 12%
.85734
.79719
1.7832
6
1.6900
5
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
$11,20
0
This 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%.
70,000
5,600
x
x
.79719
1.69005
55,80
=
3
9,46
=
4
65,26
7
The interest revenue to be recognized can then be determined using the effective
interest method.
PV at 12/31/Y2
Interest income at 12/31/Y3
($65,267 x 12%)
Interest receivable at 12/31/Y3
$65,2
67
$7,83
2
5,600
(70,000 x 8%)
Increase in carrying value of loan
PV at 12/31/Y3
2,232
67,49
9
Question 12:
PVC-0005
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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
$25,00
0
$50,00
0
$75,00
0
This 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
$150,00
CV of note
0
FMV of land
100,000
$
Gain on restructuring
50,000 the debt
Question 13:
PVB-0055
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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. Oaks gain on the purchase
of its own bonds exceeded its loss on the sale of Maples bonds. Oak should report
the
Net 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-0002
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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 & Ss year 4 income statement, the amount of the loss should be
$279,00
0
$221,00
0
$190,00
0
$100,00
0
This answer is correct. On 5/1/Y1 E & S recorded the land purchased at a cost of
$500,000.
Land
Cash
Note
payable
500,00
0
100,00
0
400,00
0
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 190,00
land
0
Note payable
310,00
0
Land
500,00
0
Question 15:
PVB-0012
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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
$209,00
0
$206,00
0
$199,00
0
This 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
Premium on bonds
payable
Bonds payable
Interest expense
?
10,00
0
6,000
200,00
0
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-0008
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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 for
2
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
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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 Jaffes December 31, year 1
balance sheet, the bonds payable should be reported at their carrying value of
$459,50
0
$477,50
0
$495,50
0
$522,50
0
This 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-0029
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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?
$17,70
6
$20,00
0
$21,24
7
$24,00
0
This answer is correct. Under the interest method, interest expense is computed as
follows:
BV of
Yiel
Intere
Time =
d
st
perio expen
d
se
$354,1 12
$21,2
6/12 =
18
%
47
bonds
rate
xx
x
xx
x
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-0010
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During year 1 Cain Corporation incurred the following costs in connection with the
issuance of bonds:
Printing and engraving
$
15,000
Legal fees
Fees paid to independent accountants for
registration information
Commissions paid to underwriter
80,000
10,000
150,00
0
Question 22:
PVB-0024
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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
$12,00
0
$14,00
0
This 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-0027
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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
$57,10
0
$54,90
0
$51,61
0
$51,00
0
This answer is correct. The solutions approach is to prepare the 12/31/Y1 interest
entry.
Interest expense
Cash
Discount on bonds
payable
93,90
0
90,00
0
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-0001
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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 debt
Exceeds 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-0018
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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
$103,00
0
$104,50
0
This 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-0013
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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
$1,016,6
67
$1,033,3
33
This 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)
Accrued interest for 2 months ($1,000,000 x
10% x 2/12)
$1,000,0
00
16,667
$1,016,6
67
Question 27:
PVA-0011
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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 notes market rate of interest was 11%. Fleur
recorded the purchase at the notes face amount. All of the merchandise was sold
by December 1, year 1. Fleurs 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. Fleurs year 1 cost of goods sold for the
holiday merchandise was
Overstated by the difference between the notes face amount and the notes
October 1, year 1 present value.
Overstated by the difference between the notes face amount and the notes
October 1, year 1 present value plus 11% interest for 2 months.
Understated by the difference between the notes face amount and the notes
October 1, year 1 present value.
Understated by the difference between the notes face amount and the notes
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), Fleurs 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-0011
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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 in
More 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 835-3045-3, 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-0054
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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 bonds 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
Bonds payable (10-yr)
xx
x
xx
x
amount of the discount. The following entry would be made on the books of the
purchaser:
Investment in bonds
(net)
Accrued interest
Cash
xx
x
xx
x
xx
x
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-0012
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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 notes market rate of interest was 11%. Fleur
recorded the purchase at the notes face amount. All of the merchandise was sold
by December 1, year 1. Fleurs 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 Fleurs accounting treatment of
the note, interest, and merchandise, which of the following items was reported
correctly?
12/31/Y1 retained
12/31/Y1 interest
earnings
payable
Yes
Yes
No
No
Yes
No
No
Yes
This answer is correct. The requirement is to determine whether Fleurs 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 yearend, resulting in the correct reporting of interest payable.
Question 32:
PVB-0015
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Carrying
amount
B/P
$46,139
$2,307
$307
$3,554
$46,446
$2,322
$322
$3,232
$46,768
Question 33:
AICPA.101132FAR
On 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?
$735,80
0
$750,00
0
$758,30
0
$825,80
0
The 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
B
C
D
E
Cash Intere Discount Carryin
st
g
1Yea paid expen amortizati amoun
r
se
on
t
21
$86,58
0
32 $6,00
0
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-0031
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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 Walls September 30, year 2 balance sheet, the amount of accrued interest
expense should be
$
2,500
$
5,000
$
7,500
$10,00
0
This 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-FA
On 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
gain
The 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-0017
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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
$191,00
0
$196,00
0
$198,50
0
$201,00
0
This 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-0023
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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 of
3
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-0001
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Bonds payable issued with scheduled maturities at various dates are called
Serial
Term
bonds
bonds
No
Yes
No
No
Yes
No
Yes
Yes
This 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-0003
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Glen Corporation had the following long-term debt:
Sinking fund bonds, maturing in
installments
Industrial revenue bonds, maturing in
installments
Subordinated bonds, maturing on a
single date
$1,100,0
00
900,000
1,500,00
0
This 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-0007
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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 Face value of
seller
bond
Yes
Yes
Yes
No
No
Yes
No
No
This answer is correct. The solutions approach is used to prepare the appropriate
journal entry
Investment in bonds
Interest receivable (or
revenue)
Cash
xx
x
xx
x
xx
x
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 bonds 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-0051
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On June 30, year 1, Dean Company had outstanding 8%, $1,000,000 face value, 15year 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?
$10,00
0
$25,00
0
$40,00
0
$70,00
0
This 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
Bond
discount
Bond issue
costs
Cash
1,000,0
00
Gain
45,000
15,000
930,00
0
10,000
xx
x
xx
x
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
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For a bond issue which sells for less than its par value, the market rate of interest is
Dependent 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-0025
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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
$190,00
0
$194,00
0
$196,00
0
$198,00
0
This 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-FA
On 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?
$54,00
0
$49,50
0
$36,00
0
$33,00
0
Although 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-0061
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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 as
Extraordinary 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
companys income statement.