Chapters 12, 14 Exam

Question 1

Why don’t bonds sell for their face value?

Answer 1

There is almost always a delay between the date the terms of issue are established and when the bond actually comes to market.

Question 2

What does the effective interest method say?

Answer 2

That interest expense recorded each period should be based on the market rate of interest rather than the stated rate.

Question 3

What happens when bonds are issued in the middle of a financial period?

Answer 3

the interest expense journal entry needs to be adjusted to reflect the partial period.

Question 4

What are zero-coupon bonds?

Answer 4

a bond that pays no interest

Question 5

What are installment notes?

Answer 5

a note payable that requires the repayment of the loaned amount through small increments, over the life of the loan

Question 6

What are common examples of installment notes?

Answer 6

car loans and home mortgage loans

Question 7

What are the two elements included in an installment note?

Answer 7

• An amount that represents interest

- an amount that represents a reduction of the loan balance.

Question 8

What is the early extinguishment of debt?

Answer 8

It refers to situations in which debt is retired and the money is paid back to the lender before maturity date.

Question 9

What are convertible bonds?

Answer 9

Bonds that can be converted into shares of stock at the option of the holder.

Question 10

Why do companies issue convertible bonds?

Answer 10

1. Company can sell the bonds at a higher price
2. They are used in merger and acquisition transactions
3. Companies with lots of debt can access the bond market.
4. They are an indirect way to issue new stock.

Question 11

What is another name for a bond with a detachable warrant?

Answer 11

A stock warrant

Question 12

What is a bond with a detachable warrant?

Answer 12

It gives an investor an option to purchase a stated number of shares of common stock at a specified option price, often within a given period of time. In this bond, the the warrant is attached to a bond.

Question 13

How do detachable warrant bonds compare to convertible bonds?

Answer 13

There are effectively two different securities when a bond has a detachable warrant, as the investor keeps the bonds and also receives shares for detachable warrants. Convertible bonds replace the bond with shares.

Question 14

What is GAAP’s definition of fair value?

Answer 14

the price that would be received to sell an asset or paid to transfer a liability in an orderly transactions between market participants at the measurement date

Question 15

How many levels are there in a fair value hierarchy?

Answer 15

3

Question 16

What is the definition of a level 1 hierarchy?

Answer 16

Observable inputs that can reflect quoted prices for identical assets and liabilities in active markets.

Question 17

What is the definition of a level 2 hierarchy?

Answer 17

Inputs other than quoted prices included in level 1 that are observable for the asset or liability, either directly or indirectly.

Question 18

What is the definition of a level 3 hierarchy?

Answer 18

Unobservable inputs.

Question 19

What is a debt investment?

Answer 19

Occurs when one company lends another company money through bonds and notes payable.

Question 20

What are the 3 classifications of debt investments?

Answer 20

• held to maturity
• trading securities
• available for sale securities

Question 21

What is the key question used to determine an investment’s classification?

Answer 21

What was investor’s purpose in lending the money?

Question 22

Why treat unrealized holding gains and losses differently depending on the type of investment?

Answer 22

The goal is to provide information that is useful to financial statement users, so the useful information depends on what the debt investor intends to do with the investment.

Question 23

What do we do with unrealized holding gains and losses?

Answer 23

Difference between market and book value, and if the difference is a held-to-maturity investment, do nothing.

Question 24

What are the three categories of equity investments and what is their classification criteria?

Answer 24

• investor has no significant influence (less than 20% of stock)
• investor has significant influence (between 20 and 50% of ownership)
• investor controls the investee (over 50% of stock)