Ch 15 - Non-current Liabilities Flashcards
Bonds effects on shareholder control
Not effected. Lenders do not have voting rights.
Bonds and income tax
Interest expense is deductible from profit - lowering the end profit and amount of tax that has to be paid.
Earnings per share and return on equity - higher or lower for bonds than equity/dividends?
Generally higher.
Financial leverage
Borrowing money at one rate and investing at a different rate
Secured vs unsecured bonds
Secured - have specific assets pledged as collateral against bond.
Unsecured (debentures) are issued against the general credit of borrower. Companies with good credit ratings use these bonds extensively.
Contractual interest rate and AKAs
Rate that is used to determine the amount of interest the borrower pays and investor receives. Original rate.
AKA Coupon interest rate or stated interest rate
Market interest rate. AKA
Rate investors demand for lending their money.
AKA effective rate
Present value
what must be invested today at a specific rate of interest over a specific amount of time.
Candlestick inc. issues $1M of 5% bonds due in five years, with interest payments semi-annually. Calculate interest.
$1M x 5% x 6/12 = $25,000 each payment.
If bond contractual interest rate is 5% and market interest rate is:
4%, bonds sell at a ___?
5% _____
6% _____
Premium
Face value
Discount
Amortized cost
face value of the bonds minus any unamortized discount or plus any premium.
Where are bonds payable recorded and what number is recorded?
Non-current liabilities section - reported at amortized cost
Effective-interest method of amortization
used to calculate interest expense so that expense reflects actual cost of borrowing. Uses Market interest rate, at the date the bonds were issued, applied to the current amortized amount.
If bonds payable were recorded at time of purchase of $1,137,092 and face value was 1,200,000. Was the bond sold at a premium, face value, or discount and what was the selling price of the bonds at as a percentage of face value?
$1,137,092 / 1.2M = .95
Bonds were sold at 95.
Bond future value is $1M and sold at $957,345.
A) What was the selling price as a percentage of face value?
B) Journalize this transaction
95.7345%
Cash 957,345
Bonds payable 957,345
Bonds payable are always reported at amortized cost.
When bonds are sold at a discount, how is the discount recorded?
FV: $1M Sold at $957,345
# of semi-annual interest periods = 10 (5 years)
contractual rate 5%
semi-Annual market interest rate: 3%
Interest payments: ___(A)
B) Calculate total cost of borrowing
A) 1M x 5% x 6/12 = $25,000
25,000 x 10 periods = $250,000 total interest
Add: Bond discount 42,655
Total cost of borrowing: $292, 655
1M - 957,345 = 42,655
Amortizing the discount/premium
Allocation of the bond discount/premium over the life of the bonds. Makes it so at end of contract, bond price = face value
What effect does amortization of the (A) discount and (B) premium have on the interest expense ?
Amortization of the discount increases the amount of interest expense.
Amortization of the premium decreases the amount of interest expense
Jan 1, 2017 RB issues $500,000 of 10 year, 4% bonds to yield a market interest rate of 5%. This results in an issue price of $461,050. Interest is paid semi-annually on Jan 1 and July 1.
A) Prepare an amortization schedule for the first 4 interest periods. Round all calculations to nearest dollar
Interest pmt: 500,000 x 4% x 6/12 = $10,000
Int exp = Bond am cost x 5% x 6/12
Period Int.pmt Int. exp Discount B. am. cost
Ja 1/17 $461,050
Ju 17 $10,000 11,526 1,526 462,576
Ja 18 10,000 11,564 1,564 464,140
Jun 18 10,000 11,603 1,603 465,743
Jan 18 10,000 11,643 1,643 467,386
Jan 1, 2017 RB issues $500,000 of 10 year, 4% bonds to yield a market interest rate of 5%. This results in an issue price of $461,050. Interest is paid semi-annually on Jan 1 and July 1.
Period Int.pmt Int. exp Discount B. am. cost
Ja 1/17 $461,050
Ju 17 $10,000 11,526 1,526 462,576
Ja 18 10,000 11,564 1,564 464,140
B)Assuming RB has a dec 31 year end, prepare the entry to record the accrual of interest and amortization of any bond discount or premium on dec 31, 2017
C)Prepare the entry to record the interest on Jan 1, 2018
D) Assuming that RB has a apr 30 year end, record interest accrual at Apr 30, 2017, and subsequent interest payment on July 1, 2017
Dec 31 Interest expense 11,526
Bonds payable 1526
Interest payable 10,000
C)
Jan 18 Interest payable 10,000
Cash 10,000
D)
Apr 17 Interest expense (4m) 7684 (11526x4/6)
Bonds payable 1017
Interest payable 6,667
Jul 1 Interest expense (2m) 3842
Interest payable 6667
Bonds payable 509
Cash 10,000
On Jan 1, 2017, Candlesticks 5-year, 5% bonds are issued to yield a market interest rate of 4%, interest due semi-annually.
FV $1M. Sold at 1,044,915
A) record the original entry for the sale
B) Record first 3 Bond amortization schedule
C) JE first interest payment
Interest: 1M x 5% x 6/12 = 25,000. int exp 1M x 2%
Cash 1,044,915
Bonds Payable 1044,915
Period Int. pmt Int exp Prem amor. bond amort
Jan 17 1044,915
Jul 17 25000 20898 4,102 1040,813
Jan 18 25000 20,816 4,184 1,036,629
Jul 18 25000 20,733 4,267 1,032,362
July 1 interest expense 20,898
Bonds payable 4,102
Cash 25,000
Candlestick sells its bonds that were issued at a premium. It retires its bonds at 103 at the end of the 4th year, after paying interest.The premium amortization schedule shows that the bonds amortized cost at the redemption date (jan 1, 2021) is 1,009,709. The entry to record the redemption Jan 1, 2021 is:
Jan 1 Bonds Payable 1,009,709
Loss on bonds redemption 20,291
Cash (1M x 103%) 1,030,000
On Jan 1, 2017, Fallon Inc sold $500,000 (face value) of bonds. Bonds are dated Jan 1, 2017, pay interest semi-annually on Jan and July 1 and will mature in 10 years. The following schedule was created:
Int to Int. Amort . Unamorti Bond
period be paid exp. Amount Am cost.
Jan 1 (33,975) 466,025
Jul 17 $17,500 $18,641 $1141 32,834 467,166
a) What is the contractual rate of interest for this bond issue?
B) What is the market rate of interest for this bond issue?
C) What was the selling price of the bonds as a percentage of the face value?
D)Prepare the JE to record the sale for the bond issue on Jan 1, 2017
E) Prepare the JE to record the payment of the interest and amortization on July 1, 2017
A) $17,500/500,000 = 0.035 x 2 = 7%
B) 18,641/467,166 = 0.0399 x 2 = 8%
C) 466,025/500,000 = 93
D) Jan 1 Cash 466,025
Bonds payable 466,025
E)
July 1 Interest expense 18,641
Cash 17,500
Bonds payable 1141
RB Issued $500,000, 10 year bonds at a discount. Prior to maturity, when the bonds’ amortized cost is $496,000 the company redeems the bonds at 98. Prepare the entry to record the redemption of the bonds
Bonds payable 496,000
Gain on redemption 6,000
Cash (500,000 x .98) 490,000
Gain on redemption. Cash paid (490,000) is less than the amortized cost of 496.
Fixed interest rate vs Floating/variable interest rate
Fixed is constant for the entire term of the note.
Floating changes as the market rates change.
Jan 1, 2017 Belanger issues a $120,000, 5 year, 7% note payable to finance a new research laboratory. Equal monthly installments of $2000 (120,000/60 months) are due on the first of each month, plus interest based on an annual rate of 7% on the outstanding principle balance.
A) record original entry
B) Calculate Interest expense on Feb 1. And record entry
C) Calculate Interest expense for Mar 1, principle balance is now $118,000 (120k-2000 pmt from feb)
Cash 120,000
Notes payable 120,000
B) $120,000 x 7% x 1/12 = $700.
Feb 1 Interest expense 700
Notes payable 2000
Cash 2,700
C) 118,000 x 7% x 1/12 = $688.
Belanger repays its $120,000 note payable in blended payments of $2,376 each month. Still has annual rate of 7% and due in 5 years. Originally issued Jan 1.
Create a payment schedule for the first 3 months
Create JE for Mar 1 entry
Period Cash Int. exp Reduc. of princ Balance
Jan 1 120,000
Feb 1 $2,376 700 1676 118,324
Mar 1 2376 690 1686 116,638
Apr 1 2376 680 1686 114,942
Mar 1 Interest expense 690
Note payable 1686
Cash 2376
The term used for bonds that are unsecured are: A) Callable bonds B) Sinking fund bonds C) Debenture bonds D) Convertible bonds
C) Debenture
The market interest rate:
A) Is the contractual interest rate used to determine the amount of cash interest paid by the borrower
B) Is listed in the bond indenture
C) Is the rate investors demand for lending funds
D) All of the above
C) rate investors demand for lending funds
A 10 year bond is issued with semi-annual interest payments. The contractual rate of the bond is 4% while the current market rate is 3%. The n and i factors to determine the price of the bond is: A) n=10 i=2% B) n=20 i=3% C) n=20 i=2% D) n=20 i=1.5%
D
If bonds are issued at a discount, it indicates that:
A) the contractual interest rate is higher than the market interest rate
B) the market interest rate is higher than the contractual interest rate
C) the contractual interest rate and market interest rate are the same
D) the bonds are junk bonds
B) the market interest rate is higher than the contractual interest rate
Communications Inc. issues 1M of 10 year 4% bonds when the market rate of interest is 5%. Interest is paid semi-annually. Investors will:
A) not buy the bonds because the market rate of interest is higher than the contractual rate of interest
B) Buy the bonds for 1M
C) Buy the bonds for more than 1M
D) buy the bonds for less than 1M
D) Buy bonds for less than 1 M
On Jan 1, Shears Corp issues $400,000 of 5 year, 4% bonds at 101. The entry to record the issue of the bonds is:
Cash 404,000
Bonds payable 404,000
When bonds are issued at a discount, the discount is amortized over the life of the bonds. The best reason for amortizing the bond discount is to:
A) reflect that the bond discount is considered an increase in the cost of borrowing
B) Decrease the amortized cost of the bond to its face value at maturity
C) reflect that the bond discount is considered a reduction in the cost of borrowing
D) ensure the bond payable is recorded at its fair value over the life of the bond
A) reflect that the bond discount is considered an increase in the cost of borrowing
Gester cord redeems its $100,000 face value bonds at 105 on Jan 1, after the payment of semi-annual interest. The amortized cost of the bonds at the redemption date is $103,745. The entry to record the redemption will be:
Bond payable 103,745
Loss on redemption 1,255
Cash 105,000
Zhang Inc issues a $497,000 3 year, 7% installment note payable on Jan 1. The note will be paid in 3 annual blended payments of $189,383 each. What is the amount of interest expense that should be recognized by Zhang in the second year?
A) 21,533 B) 23, 193 C) 23,968 D) 34,790
pmt int exp reduc of prin balance
Jan 1 497,000
Jan 1 189,383 34,790 int. 154,593 342,407
jan 1 183,383 23,969
C)
zhang inc issues a $497,000 3 year, 7% installment note payable on Jan 1. The note will be paid in fixed yearly principle payments of $165,667. What is the amount of interest that should be recognized the the 2nd year?
A) $25,628 B) 23,193 C) 11,596 D) 34,790
pmt int exp reduc of princ balance
497,000
1 200,457 34,790 165,667 331,333
2 xxxxxxx 23,193
B)
The lease term for Lease A is equal to 74% of the estimated economic life of the leased property. The lease term for Lease B is equal to 45% of the estimated economic life of the leased property. Assuming the lessee reports under IFRS and no other conditions are met, how should the lessee classify these leases?
Lease A Lease B
A) Operating lease FInance lease
B) Operating lease Operating lease
C) Finance lease Operating lease
D) Finance lease Finance lease
C
Which of the following situations would most likely indicate that a company’s solvency has deteriorated?
A) Increasing debt to total assets and increasing interest coverage ratios
B) Decreasing debt to total assets and decreasing interest coverage ratios
C) Increasing debt to total assets and decreasing interest coverage ratios
D) Decreasing debt to to total assets and increasing interest coverage ratios
C)
