4.4 Accounting for Bonds Payable Flashcards
When the amount received from sales of the bonds at issuance exceeds the face value of the bonds, _____ arises
A premium on bonds payable
On January 1, Evangel Company issued 9% bonds in the face amount of $100,000, which mature in 5 years. The bonds were issued for $96,207 to yield 10%, resulting in a bond discount of $3,793. Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on December 31.
What is the amount of interest Evangel will pay at the end of the first year?
$9,000
The annual cash payment is the face amount of the bonds times the stated rate
($100,000 x 9%)
Clare Co. issued US $6 million of 12% bonds on December 1, Year 1, due on December 1, Year 6, with interest payable each December 1 and June 1. The bonds were sold for US $5,194,770 to yield 16%.
If the discount were amortized by the effective interest method, Clare’s interest expense for the fiscal year ended November 30, Year 2, related to its $6 million bond issue would be
A. $623,372
B. $720,000
C. $831,163
D. $835,610
D. $835,610
Under the effective interest method, interest expense is equal to the carrying amount of the bonds at the beginning of the interest period time the effective interest rate.
The carrying amount of the bonds at December 1, Year 1 (the issuance date), was $5,194,770. The annual yield rate was 16%. Interest expense is equal to 5,194,770 x 16% x (6 months/12 months) = $415,582. For the same period, interest paid was $6,000,000 x 12% x (6 months / 12months) = $360,000. Hence, the semiannual discount amortization was $415,582 - $360,000, and the carrying amount of the bonds for the second 6 month period was 5,194,770 + 55,582. For this period, the semiannual interest expense was $420,028 [5,250,352 x 16% x (6mo/12mo)]. Total interest expense for the year is equal to $835,610 (415,582+420,028).
On January 1, Year 1, Gilson Corporation issued 1,000 of its 9%, $1,000 callable bonds for $1,030,000. The bonds are dated January 1, Year 1, and mature on December 31, Year 15. 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 8, and the market price of the bonds was 99 on this date. In its December 31, Year 8, balance sheet, at what amount should Gilson report the carrying value of the bonds?
A. $1,014,000
B. $1,016,000
C. $1,020,000
D. $990,000
A. $1,014,000
The face amount of the bonds is $1,000,000 (1,000 x $1,000), and the unamortized premium is $14,000 (given). The carrying amount is thus $1,014,000. The other data are irrelevant.
On January 1, Year 4, Celt Corp. issued 9% bonds in the face amount of $1 million, which mature on January 1, Year 14. The bonds were issued for $939,000 to yield 10%, resulting in a bond discount of $61,000. Celt uses the effective interest method of amortizing bond discount. Interest is payable annually on December 31. At December 31, Year 4, Celt’s unamortized bond discount should be
A. $51,610
B. $52,000
C. $51,000
D. $57,100
D. $57,100
For the first year, interest expense is $93,900 ($939,000 carrying amount x 10% yield rate). The periodic interest payment is $90,000 ($1,000,000 face amount x 9% coupon rate). The $3,900 ($93,900 - $90,000) difference is the amount of bond discount amortized. Thus, the $61,000 unamortized bond discount at the beginning of the year should be reduced by $3,900 to a year-end balance of $57,100.
How is the carrying amount of a bond payable affected by amortization of the following?
Discount: increase/decrease
Premium: increase/decrease
Discount: increase
Premium: decrease
The carrying amount of a bond payable is equal to its maturity (face) amount plus any unamortized premium or minus any unamortized discount. Amortization results in a reduction of the discount or premium. Consequently, the carrying amount of a bond is increased when discount is amortized and decreased when premium is amortized.
When using fair value accounting, it would be to a firm’s benefit to report the liability at fair value when it has
A. $25 million in put-able bonds trading at 102
B. $32 million in outstanding bonds trading at 101
C. $28 million in outstanding bonds trading at 98
D. $50 million in variable-rate preferred shares outstanding
C. $28 million in outstanding bonds trading at 98
A firm would want to report a liability at fair value when its fair value is less than its carrying amount. The fair value of this bond ($27,440,000 = 28,000,000 * .98) is less than its carrying amount of $28,000,000. This would decrease the liabilities section of the balance sheet, which a company would prefer to do.
When debt is issued at a discount, interest expense over the term of debt equals the cash interest paid
A. Minus discount minus par value
B. Minus discount
C. Plus discount plus par value
D. Plus discount
D. Plus discount
Debt is sold at a discount when it sells for less than its face amounts, that is, when the contract (stated) interest rate is less than the market (effective) interest rate. Under the effective interest method required by GAAP, the difference between interest expense and interest paid is the discount amortization. When debt is issued at a discount, interest expense exceeds interest (cash) paid. The entry is to debit interest expense, credit discount, and credit cash. Consequently, interest expense equals the sum of the periodic interest payments and the discount.
On January 1, Evangel Company issued 9% bonds in the face amount of $100,000, which mature in 5 years. The bonds were issued for $96,207 to yield 10%, resulting in a bond discount of $3,793. Evangel uses the effective interest method of amortizing bond discount. Interest is payable annually on December 31.
The net carrying amount of Evangel’s
bonds payable at the end of the first year is
A. $94,866
B. $97,548
C. $95,586
D. $96,828
D. $96,828
Total interest expense for the year equals the carrying amount of the bonds times the effective rate (yield), or $9,621 ($96,207 x 10%). Subtracting the cash interest payment from this leaves the amount of discount amortized ($9,621 - $9,000 = $621). Subtracting this amount from the previous unamortized discount ($3,793) leaves a remaining unamortized discount at the end of Year 1 of $3,172. Subtracting this amount from the face amount of the bonds ($100,000) provides a carrying amount of $96,828.
On January 1, Year 2, Oak Co. issued 400 of its 8%, $1,000 bonds at 97 plus accrued interest. The bonds are dated October 1, Year 1, and mature on October 1, Year 11. 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 $8,000. On January 1, Year 2, what amount should Oak report as bonds payable, net of discount?
A. $388,300
B. $380,300
C. $388,000
D. $392,000
C. $388,000
A bond issued “at 97” is issued at a price equal to 97% of its face amount (400 bonds × $1,000 face amount × .97 = $388,000). At the issue date, no time has passed, so no amortization has occurred, and the accrued interest is credited to either interest payable or interest expense. The reported amount is therefore $388,000 ($400,000 – $12,000).
