Chapter 10: Long-term liabilities Flashcards
Which interest rate, the face rate or the market rate, should be used when calculating the issue price of a bond? Why?
The issue price of a bond should always be calculated using the market rate of interest. The market rate is used to calculate the present value of the interest payments and the present value of the principal (and therefore the issue price).
What is the tax advantage that companies experience when bonds are issued instead of stock?
The tax advantage for bonds is the fact that interest paid on bonds is an expense that is deductible for tax purposes, whereas dividends paid on stock are not deductible.
Does the issuance of bonds at a premium indicate that the face rate is higher or lower than the market rate of interest?
When bonds are issued at a premium, it is an indication that the face rate of interest (also called the stated rate, nominal rate, contract rate, or coupon rate) is higher than the market rate.
How does the effective interest method of amortization result in a constant rate of interest?
By basing each period’s interest expense on a decreasing or increasing amount, the amount of interest expense is different each period, but the rate of interest remains the same.
Does amortization of a premium increase or decrease the bond carrying value? Does amortization of a discount increase or decrease the bond carrying value?
Amortization of a premium decreases the bond carrying value because it decreases the Premium on Bonds Payable account. Since Discount on Bonds Payable is a contra-liability account, amortization of a discount increases the bond carrying value.
Is there always a gain or loss when bonds are redeemed? How is the gain or loss calculated?
Gain or loss on bond redemption will almost always occur when bonds are redeemed or retired before their scheduled due date. The gain or loss is computed as the difference between the bond carrying value and the redemption price at the time the bonds are redeemed.
What are the reasons that not all leases are accounted for in the same manner? Do you think it would be possible to develop a new accounting rule that would treat all leases in the same manner? Explain.
Leases are not all accounted for in the same manner because of the variety of provisions that can be found in lease agreements. Some leases are only short-term rental arrangements to use the asset, and others are actually purchases of the asset over a long time period. It may be possible to develop an accounting rule to treat all leases similarly. However, the rule must also be flexible enough to cover the wide variety of financial arrangements that are all called leases.
