F4 - Deck 2

Question 1

How is the market price of a bond determined?

Answer 1

The market price of a bond is the sum of the present value of the principal and all interest payments, calculated using the market interest rate.

The stated interest rate determines the payment amount, not the market price.

Question 2

What is the reported valuation of a bond payable?

Answer 2

Face Value less any unamortized bond discount.

Question 3

Describe these type of bonds:
Variable Rate
Debenture
Term
Serial

Answer 3

Variable Rate: have interest rates that change.
Debenture: are unsecured bonds.
Term: are bonds that have a single fixed maturity date.
Serial: re pre-numbered bonds that the issuer may call and redeem a portion by serial number (Installment Bond)

Question 4

How should the issue price of bonds with detachable warrants be allocated?

Answer 4

The issue price of bonds with detachable warrants should be allocated based on the fair values of each component at issuance. The value assigned to the warrants is their fair value, and the remainder is allocated to the bonds.
The relationship between the warrants’ fair value and the bonds’ face value does not affect the allocation.

Question 5

How does the issuance of a new bond affect long-term liabilities on the balance sheet?

Answer 5

Long-term liabilities increase by the difference between the carrying amount of the old bond and the face amount of the new bond. Bond liability is reported net of any unamortized discount, and any loss from the exchange cannot be deferred.

Question 6

What are the characteristics of par value bonds regarding market rate, amortization, and interest expense?

Answer 6

For par value bonds, the market rate at issuance equals the coupon rate, resulting in no premium or discount to amortize. Interest expense each period equals the interest payable, with no adjustment for amortization.

Question 7

What are the steps to price a bond?

Answer 7

1. Understand stand if the bond is a discount or premium (stated greater than market, premium).
2. Total payment amount. Stated rate times total bond issuance, divide if needed for semi-annual payments.
3. Take bond issuance and time it by Present value of $1. Take total payment amount in 2. and times by present value of ordinary annuity.
4. Add both values in 3. and will be bond price

Question 8

How is interest expense on a bond payable calculated?

Answer 8

Interest expense on a bond payable is the sum of interest paid and the amortization of any discount or premium.

For a discount bond, the carrying value increases each period, leading to a larger interest expense each year. The increase in interest expense is greater in later years.

Question 9

What is the impact of not amortizing a bond premium on financial statements?

Answer 9

Not amortizing a bond premium results in overstated interest expense and understated net income, which ultimately leads to an understatement of stockholder’s equity.

Question 10

How to calculate bond issuance amount received (cash proceeds)?

Answer 10

1. Face Value * % of issuance
2. Face Value * Coupon rate THEN * Months completed (X/12)
3. Add 1. (Bond issue proceeds and 2. Accrued interest. Total cash proceeds.

Question 11

What is the impact of amortizing a discount on a bond or note?

Answer 11

Amortizing a discount on a bond or note increases interest expense for the period.
It is distinct from pension plan interest, interest on software development, and deferred compensation plan interest, which are reported as components of their respective expenses.

Question 12

How is interest payable on a bond calculated?

Answer 12

Interest payable on a bond is calculated by multiplying the face value of the bond at the beginning of the period by the contractual interest rate.

Question 13

How is interest expense calculated when debt is issued at a discount?

Answer 13

Interest expense for discounted debt equals cash interest paid plus the amortization of the discount.
Remember, the discount is a debit balance that is reduced by crediting it during amortization.

Question 14

How is the ending carrying amount of a bond issued at a discount determined using the effective interest amortization method?

Answer 14

The ending carrying amount of a bond issued at a discount is the beginning carrying amount plus the discount amortized during the period. Discount amortization increases the carrying amount, unlike premium bonds where amortization is subtracted.

Question 15

How is a loss recognized on the retirement of debt and where is it reported?

Answer 15

A loss is recognized on debt retirement when the settlement price exceeds the book value. The gain or loss on bond retirements is reported in income from continuing operations, not in other comprehensive income.

Question 16

Why might a callable bond be more likely to be called as interest rates move lower?

Answer 16

A callable bond is more likely to be called as interest rates decrease because it allows the issuer to refinance the debt at lower rates.
The call option benefits the issuer, leading bondholders to demand a higher return for the risk of early redemption and reinvestment at lower rates.

Question 17

How are gains from the early retirement of debt recognized and reported?

Answer 17

Gains from early retirement of debt are recognized at the time of the transaction and included in continuing operations. They are not reported as a reduction of interest expense or net of income taxes.

Question 18

What is the accounting treatment for a bond issued above par and redeemed below par?

Answer 18

When a bond is issued above par and redeemed below par, the issuer will book a gain in income from continuing operations.
This gain reflects the issuer paying less than par to remove a liability recorded at a higher value, and it is correctly placed in income from continuing operations rather than as an accounting adjustment.

Question 19

What is the accounting treatment for a bond issued at a discount and redeemed above par?

Answer 19

When a bond is issued at a discount and redeemed above par, the issuer will book a loss in income from continuing operations. This is because the issuer pays more to remove the liability than its book value.

Question 20

How are unamortized bond issuance costs and losses on bond redemptions treated?

Answer 20

Unamortized bond issuance costs are deducted from the carrying value at redemption, increasing the loss. Gains and losses on bond redemptions are booked on the income statement.

Question 21

What are the methods to extinguish a bond liability?

Answer 21

A legal release or paying off the bond at or prior to maturity will extinguish the liability.
An in-substance defeasance does not extinguish the liability but freezes the payments until a later time.