EFFECTIVE INTEREST METHOD

Question 1

QUESTION 46-6 Multiple choice (IAA)
1. What is the interest rate written on the face of the bond?
a. Coupon rate
b. Nominal rate
c. Stated rate
d. Coupon rate, nominal rate or stated rate

Answer 1

d. Coupon rate, nominal rate or stated rate

Question 2

2. What is the rate of interest actually incurred?
   a. Market rate
   b. Yield rate
   c. Effective rate
   d. Market, yield or effective rate

Answer 2

d. Market, yield or effective rate

Question 3

4. A discount on bond payable is charged to interest expense
   a. Equally over the life of the bond
   b. Only in the year the bond is issued
   c. Using the effective interest method
   d. Only in the year the bond matures

Answer 3

c. Using the effective interest method

Question 4

3. When the effective interest method is used, the periodic amortization would
   a. Increase if the bonds were issued at a discount.
   b. Decrease if the bonds were issued at a premium.
   c. Increase if the bonds were issued at a premium.
   d. Increase if the bonds were issued at either a discount or a premium.

Answer 4

d. Increase if the bonds were issued at either a discount or a premium.

Question 5

5. Under the effective interest method of amortization, the interest expense is equal to
   a. The stated rate of interest multiplied by the face amount of the bonds.
   b. The market rate of interest multiplied by the face
   amount of the bonds.
   c. The stated rate of interest multiplied by the beginning carrying amount of the bonds.
   d. The market rate of interest multiplied by the beginning carrying amount of the bonds.

Answer 5

d. The market rate of interest multiplied by the beginning carrying amount of the bonds.

Question 6

6. When interest expense for the current year is more than interest paid, the bonds were issued
   a. A discount
   b. A premium
   c. Face amount
   d. An indeterminable amount

Answer 6

a. A discount

Question 7

7. When interest expense for the current year is less than interest paid, the bonds were issued at
   a. A discount
   b. A premium
   c. Face amount
   d. An indeterminable amount

Answer 7

b. A premium

Question 8

8. Bond issue cost
   a. Is included in the measurement of the bonds payable measured at amortized cost.
   b. Is amortized using the interest method over the life of the bonds payable.
   c. Will effectively increase the market rate of interest.
   d. All of these relate to bond issue cost.

Answer 8

d. All of these relate to bond issue cost.

Question 9

9. Bonds usually sell at
   a. Maturity amount
   b. Face amount
   c. Present value
   d. Statistical expected value

Answer 9

c. Present value

Question 10

10. Which statement is true about bonds payable?
    a. The specific provisions of a bond issue are described in a document called bond indenture.
    b. Periodic interest expense is the stated interest rate times the amount of bond outstanding.
    c. Bonds will sell for a premium when the market rate
    of interest exceeds stated rate.
    d. The initial sale price of bond represents the sum of all future cash outflows.

Answer 10

a. The specific provisions of a bond issue are described in a document called bond indenture.

Question 11

1. When bonds are sold at a premium, at each subsequent interest payment date, the cash paid is
   a. Less than the effective interest
   b. Equal to the effective interest
   c. Greater than the effective interest
   d. More than if the bonds had been sold at a discount

Answer 11

c. Greater than the effective interest

Question 12

2. When bonds are sold at a discount, at each subsequent interest payment date, the cash paid is
   a. More than the effective interest
   b. Less than the effective interest
   c. Equal to the effective interest
   d. More than if the bonds had been sold at a premium

Answer 12

b. Less than the effective interest

Question 13

3. When bonds are sold at a discount, at each interest payment date, the interest expense
   a. Increases
   b. Decreases
   c. Remains the same
   d. Is equal to the change in carrying amount

Answer 13

a. Increases

Question 14

5.Interest expense is
a. The effective rate times the carrying amount of the bond during the interest period.
b. The stated rate times the face amount of the bond
c. The effective rate times the face amount of the bond.
d. The stated interest rate times the carrying amount.

Answer 14

a. The effective rate times the carrying amount of the bond during the interest period.

Question 14

4. When bonds are sold at a premium, at each interest payment date, the interest expense
   a. Remains constant
   b. Is equal to the change in carrying amount
   c. Increases
   d. Decreases

Answer 14

d. Decreases

Question 15

1. What is the effective interest rate of a bond measured at amortized cost?
   a. The stated rate of the bond.
   b. The interest rate currently charged by the entity or by others for similar bond.
   c. The interest rate that exactly discounts estimated future cash payments through the expected life of the bond or when appropriate, a shorter period to the net carrying amount of the bond.
   d. The basic risk-free interest rate that is derived from observable government bond prices.

Answer 15

c. The interest rate that exactly discounts estimated future cash payments through the expected life of the bond or when appropriate, a shorter period to the net carrying amount of the bond.

Question 16

2. For a bond issue which sells for less than face amount, the market rate of interest is
   a. Dependent on rate stated on the bond
   b. Equal to rate stated on the bond
   c. Less than rate stated on the bond
   d. Higher than rate stated on the bond

Answer 16

d. Higher than rate stated on the bond

Question 17

3. What is the market rate of interest for a bond issue which sells for more than face amount?
   a. Less than rate stated on the bond
   b. Equal to rate stated on the bond
   c. Higher than rate stated on the bond
   d. Independent of rate stated on the bond

Answer 17

a. Less than rate stated on the bond

Question 18

4. If bonds are issued at a premium, this indicates that
   a. The yield rate of interest exceeds the nominal rate
   b. The nominal rate of interest exceeds the yield rate
   c. The yield and nominal rates coincide
   d. No necessary relationship exists between the two rates

Answer 18

b. The nominal rate of interest exceeds the yield rate

Question 19

5. Which statement is true for a bond maturing on a single date when the effective interest method of amortizing discount on bonds payable is used?
   a. Interest expense as a percentage of the bond carrying amount varies from period to period
   b. Interest expense increases each six-month period
   c. Interest expense remains constant each six-month period
   d. Nominal interest rate exceeds effective interest rate

Answer 19

b. Interest expense increases each six-month period

Question 20

6. The market price of a bond issued at a discount is the present value of the principal amount at the market rate of interest
   a. Less the present value of all future interest payments
   at the market rate of interest.
   b. Less the present value of all future interest payments at the rate of interest stated on the bond.
   c. Plus the present value of all future interest payments at the market rate of interest.
   d. Plus the present value of all future interest payments at the rate of interest stated on the bond.

Answer 20

c. Plus the present value of all future interest payments at the market rate of interest.

Question 21

7. In theory, the proceeds from the sale of a bond would be equal to
   a. The face amount of the bond
   b. The present value of the principal amount due at the end of the life of the bond plus the present value of the interest payments made during the life of the bond
   c. The face amount of the bond plus the present value of the interest payments made during the life of the bond
   d. The sum of the face amount of the bond and the periodic interest payments.

Answer 21

b. The present value of the principal amount due at the end of the life of the bond plus the present value of the interest payments made during the life of the bond

Question 22

8. Under international accounting standard, the valuation method used for bonds payable is
   a. Historical cost
   b. Discounted cash flow valuation at current yield rate
   c. Maturity amount
   d. Discounted cash flow valuation at yield rate at issuance

Answer 22

d. Discounted cash flow valuation at yield rate at issuance

Question 23

9. How should an entity calculate the net proceeds to be received from bond issuance?
   a. Discount the bonds at the stated rate of interest.
   b. Discount the bonds at the market rate of interest.
   c. Discount the bonds at the stated rate of interest and
   deduct bond issuance cost.
   d. Discount the bonds at the market rate of interest and deduct bond issuance cost.

Answer 23

d. Discount the bonds at the market rate of interest and deduct bond issuance cost.

Question 24

10. An entity issued a bond with a stated rate of interest that is less than the effective interest rate on the date of issuance. The bond was issued on one of the interest payment dates. What should the entity report on the first interest payment date?
    a. An interest expense that is less than the cash payment made to bondholders.
    b. An interest expense that is greater than the cash payment made to bondholders.
    c. A debit to discount on bond payable.
    d. A debit to premium on bond payable.

Answer 24

b. An interest expense that is greater than the cash payment made to bondholders.