Ch 15 - Non-current Liabilities

Question 1

Bonds effects on shareholder control

Answer 1

Not effected. Lenders do not have voting rights.

Question 2

Bonds and income tax

Answer 2

Interest expense is deductible from profit - lowering the end profit and amount of tax that has to be paid.

Question 3

Earnings per share and return on equity - higher or lower for bonds than equity/dividends?

Answer 3

Generally higher.

Question 4

Financial leverage

Answer 4

Borrowing money at one rate and investing at a different rate

Question 5

Secured vs unsecured bonds

Answer 5

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.

Question 6

Contractual interest rate and AKAs

Answer 6

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

Question 7

Market interest rate. AKA

Answer 7

Rate investors demand for lending their money.

AKA effective rate

Question 8

Present value

Answer 8

what must be invested today at a specific rate of interest over a specific amount of time.

Question 9

Candlestick inc. issues $1M of 5% bonds due in five years, with interest payments semi-annually. Calculate interest.

Answer 9

$1M x 5% x 6/12 = $25,000 each payment.

Question 10

If bond contractual interest rate is 5% and market interest rate is:
4%, bonds sell at a ___?
5% _____
6% _____

Answer 10

Premium
Face value
Discount

Question 11

Amortized cost

Answer 11

face value of the bonds minus any unamortized discount or plus any premium.

Question 12

Where are bonds payable recorded and what number is recorded?

Answer 12

Non-current liabilities section - reported at amortized cost

Question 13

Effective-interest method of amortization

Answer 13

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.

Question 14

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?

Answer 14

$1,137,092 / 1.2M = .95

Bonds were sold at 95.

Question 15

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

Answer 15

95.7345%

Cash 957,345
Bonds payable 957,345

Bonds payable are always reported at amortized cost.

Question 16

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

Answer 16

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

Question 17

Amortizing the discount/premium

Answer 17

Allocation of the bond discount/premium over the life of the bonds. Makes it so at end of contract, bond price = face value

Question 18

What effect does amortization of the (A) discount and (B) premium have on the interest expense ?

Answer 18

Amortization of the discount increases the amount of interest expense.
Amortization of the premium decreases the amount of interest expense

Question 19

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

Answer 19

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

Question 20

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

Answer 20

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

Question 21

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

Answer 21

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

Question 22

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:

Answer 22

Jan 1 Bonds Payable 1,009,709
Loss on bonds redemption 20,291
Cash (1M x 103%) 1,030,000

Question 23

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

Answer 23

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

Question 24

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

Answer 24

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.

Question 25

Fixed interest rate vs Floating/variable interest rate

Answer 25

Fixed is constant for the entire term of the note.

Floating changes as the market rates change.

Question 26

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)

Answer 26

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.

Question 27

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

Answer 27

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

Question 28

The term used for bonds that are unsecured are:
A) Callable bonds
B) Sinking fund bonds
C) Debenture bonds
D) Convertible bonds

Answer 28

C) Debenture

Question 29

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

Answer 29

C) rate investors demand for lending funds

Question 30

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%

Answer 30

D

Question 31

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

Answer 31

B) the market interest rate is higher than the contractual interest rate

Question 32

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

Answer 32

D) Buy bonds for less than 1 M

Question 33

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:

Answer 33

Cash 404,000

Bonds payable 404,000

Question 34

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

Answer 34

A) reflect that the bond discount is considered an increase in the cost of borrowing

Question 35

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:

Answer 35

Bond payable 103,745
Loss on redemption 1,255
Cash 105,000

Question 36

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

Answer 36

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)

Question 37

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

Answer 37

pmt int exp reduc of princ balance
497,000
1 200,457 34,790 165,667 331,333
2 xxxxxxx 23,193

B)

Question 38

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

Answer 38

C

Question 39

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

Answer 39

C)