Bonds, Leases, and Liabilities Flashcards
O
W
N
S
(O) Ownership transfers at the end of the lease.
(W) Written option for bargain purchase.
(N) PV of minimum lease payments = 90% of FV of leased property.
(S) Lease term = 75% of asset useful life.
What is the journal entry to record bonds with Stock Warrants attached.
- Calculate the cash at the discount or premium as normal.
- Bonds Payable will be the calculated face value.
- Warrants will be = Market Price * (# of Bonds * # of Warrants) * Warrant Market Price.
- Squeeze into the Discount or Premium on Bonds.
A bond issued on June 1, of the current year, has interest payment dates of April 1 and October 1. Bond interest expense for the current year ended December 31 is for a period of:
a. Seven months.
b. Four months.
c. Three months.
d. Six month
Choice “a” is correct. Interest expense is recognized for the entire period from bond issuance (June 1) through the fiscal year end (December 31).
On March 1, Year 1, Somar Co. issued 20-year bonds at a discount. By September 1, Year 6, the bonds were quoted at 106 when Somar exercised its right to retire the bonds at 105. The amount is material and considered to be unusual in nature and infrequently occurring with respect to Somar Co. How should Somar report the bond retirement on its Year 6 income statement under U.S. GAAP?
a. A gain in continuing operations.
b. An extraordinary loss.
c. A loss in continuing operations.
d. An extraordinary gain.
Choice “b” is correct. The settlement price is greater than the face value of the debt and the face value is greater than the book value. Therefore, the settlement price is greater than the book value and a loss would be recognized on the transaction. This loss would be classified as “extraordinary” because it meets the U.S. GAAP criteria
On March 1, Year 1, Evan Corp. issued $500,000 10% nonconvertible bonds at 103, due on February 28, Year 11. Each $1,000 bond was issued with 30 detachable stock warrants, each of which entitled the holder to purchase, for $50, one share of Evan’s $25 par common stock. On March 1, Year 1, the market price of each warrant was $4. By what amount should the bond issue proceeds increase stockholders’ equity?
a. $15,000
b. $45,000
c. $60,000
d. $0
Choice “c” is correct. Stockholders’ equity is increased by the value of the warrants. There are 500 bonds with 30 warrants worth $4 each. 500 x 30 x $4 = $60,000.
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?
a. Yes Yes
b. No No
c. Yes No
d. No Yes
Choice “b” is correct. No - No.
The carrying value is less than the cash paid by the investor because accrued interest is included in the cash.
The carrying value is less than the face amount of the bond because it was purchased at a discount.
What is accrued interest on a bond?
The interest that has accumulated on a bond since the last interest payment up to, but not including, the settlement date.
Accrued interest is added to the contract price of a bond transaction. Accrued interest is that which has been earned since the last coupon payment. Because the bond hasn’t expired or the next payment is not yet due, the owner of the bond hasn’t officially received the money. If he or she sells the bond, accrued interest is added to the sale price.
Which of the following is generally associated with the terms of convertible debt securities?
a. An initial conversion price that is less than the market value of the common stock at time of issuance.
b. A noncallable feature.
c. An interest rate that is lower than nonconvertible debt.
d. A feature to subordinate the security to nonconvertible debt
Choice “c” is correct. The interest rate on convertible debt is generally lower than nonconvertible debt because of the value of the conversion feature.
Which of the following is reported as interest expense?
a. Deferred compensation plan interest.
b. Amortization of discount of a note.
c. Pension cost interest.
d. Interest incurred to finance a software development for internal use.
Choice “b” is correct. When a discount on a bond or note is amortized, the discount amortization increases interest expense for the period.
On January 1, Stunt Corp. had outstanding convertible bonds with a face value of $1,000,000 and an unamortized discount of $100,000 accounted for using U.S. GAAP. On that date, the bonds were converted into 100,000 shares of $1 par stock. The market value on the date of conversion was $12 per share. The transaction will be accounted for with the book value method. By what amount will Stunt’s stockholders’ equity increase as a result of the bond conversion under U.S. GAAP?
a. $1,200,000
b. $900,000
c. $100,000
d. $1,000,000
Choice “b” is correct. When the book value method is used to account for the conversion of bonds to stock, the stock issued is recorded at the carrying value of the bonds. In this problem, the bonds have a carrying value of $900,000 ($1,000,000 face value - $100,000 discount), so the 100,000 shares of stock will be recorded at $900,000, resulting in a $900,000 increase in stockholders’ equity.
What type of bonds in a particular bond issuance will not all mature on the same date?
a. Term bonds. b. Sinking fund bonds. c. Debenture bonds. d. Serial bonds.
Choice “d” is correct. Serial bonds are bonds that mature in installments
Which of the following statements characterizes convertible debt under U.S. GAAP?
a. The holder of the debt must be repaid with shares of the issuer’s stock.
b. No value is assigned to the conversion feature when convertible debt is issued.
c. The issuer’s stock price is less than market value when the debt is converted.
d. The transaction should be recorded as the issuance of stock.
Choice “b” is correct. Under U.S. GAAP, because the conversion feature cannot be sold or transferred separate from the bonds themselves, no value is assigned to the conversion feature when the bonds are issued.
In Year 1, Lee Co. acquired, at a premium, Enfield, Inc. 10-year bonds classified as a held-to-maturity investment. At December 31, Year 2, Enfield’s bonds were quoted at a small discount. Which of the following situations is the most likely cause of the decline in the bonds’ market value?
a. Enfield is expected to call the bonds at a premium, which is less than Lee’s carrying amount.
b. Enfield issued a stock dividend.
c. Interest rates have increased since Lee purchased the bonds.
d. Interest rates have declined since Lee purchased the bonds.
Choice “c” is correct. If interest rates have increased, then the bonds’ interest rate would be less attractive to investors now than when the bonds were originally issued. This would most likely cause a decline in the bonds’ market value. Note that because the bond investment is classified as held-to-maturity, the investment will be reported at amortized cost, not fair value.
When the effective interest method of amortization is used for bonds issued at a premium, the amount of interest payable for an interest period is calculated by multiplying the:
a. Carrying value of the bonds at the beginning of the period by the contractual interest rate.
b. Carrying value of the bonds at the beginning of the period by the effective interest rates.
c. Face value of the bonds at the beginning of the period by the effective interest rates.
d. Face value of the bonds at the beginning of the period by the contractual interest rate.
Choice “d” is correct. The interest payable on a bond is calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual interest rate.
Calculate Gain
Bonds at face value $ 1,000,000
Add: Unamortized bond premium 78,000
Carrying value of bonds to be retired 1,078,000
Less: Cash paid (1,000 bonds at 102) (1,020,000)
Gain on bond retirement $ 58,000
