Bonds Payable

Question 1

On March 1, 2005, 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, 2005, affected by the error?
Bond carrying amount Retained earnings
Overstated Overstated
Understated Understated
Overstated Understated
Understated Overstated

Answer 1

The SL method recognizes the average amount of discount amortization every period, which must be larger than under the effective interest method early in the bond term. Thus, interest expense under the SL method results in higher interest expense, lower retained earnings, and higher bond carrying value because more discount is amortized early in the bond term than under the effective interest method.

Question 2

what is the current portion called

Answer 2

current maturities of long term debt

Question 3

7 items of information

Answer 3

face (maturity) value
stated interest rate
interest payment dates
market (yield, effective) interest rate
bond date
issuance date
maturity date

Question 4

what bond matures serially

Answer 4

serial

Question 5

what bond matures at once

Answer 5

term or single maturity

Question 6

a premium results because

Answer 6

stated rate > market rate

Question 7

a discount results because

Answer 7

market rate > stated rate

Question 8

entry to record issuance of bond

Answer 8

cash
discount
bond payable (face value)

Question 9

2 methods of amorization

Answer 9

effective interest

SL method

Question 10

effective interest method

Answer 10

interest exp(yieldxissue price)
discount on bonds payable (plug)
cash(stated ratexface)

Question 11

SL method

Answer 11

interest expense (plus)
discount (original discount/months)
cash (stated ratexface)

Question 12

purpose of amortization of premiums and discounts

Answer 12

to adjust interest expense to reflect the market rate of interest and to ensure that the book value at maturity equals face value

Question 13

premium amorization entry

Answer 13

interest exp
premium
cash

Question 14

discount amorization entry

Answer 14

interest exp
discount
cash

Question 15

is a value assigned to the conversion feature when convertible debt is issued

Answer 15

No value is assigned to the conversion feature when convertible debt is issued

Question 16

is a convertible debt securities interest rate lower than nonconvertible debt.

Answer 16

Investors of convertible debt receive the security of debt (guaranteed principal and interest) plus the option of converting to stock if the value of the stock has appreciated. This conversion feature entices investors to accept a lower interest rate than would be given with a non-convertible debt issue.

Question 17

When bonds are converted to stock and accounted for by the book value method what happens to owners equity

Answer 17

the owners’ equity is increased by the book value of the bonds.

Question 18

are the entire proceeds treated as selling price of bond

Answer 18

yes

Question 19

2 methods for conversion

Answer 19

book value and market value

Question 20

entry for bookvalue method

Answer 20

bonds payable
discount
common stock
contribution capital in excess of par

Question 21

entry for market value method

Answer 21

bond payable
loss on conversion of bond
  discount
  common stock
  contribution capital in excess of par

Question 22

entry for induced conversion

Answer 22

bond payable
expense for bond conversion
  discount
  common stock
  contribution capital in excess of par