Present Value of bonds Flashcards
Question 1: PVB-0059 Need a hint?See Reference... On January 1, year 1, Jackson Corporations issued 100 of its 5% twenty-year, $1,000 bonds with detachable stock warrants at par. Each bond carried a detachable warrant for one share of Jackson’s common stock at a specified price of $20 per share. Immediately after the issuance, the market value of the bonds without the warrants was $108,000, and the market value of the warrants was $12,000. At what amount should Jackson record the warrants on January 1, year 1? $0 $4,000 $10,000 $12,000
$10,000
This answer is correct. ASC Subtopic 470-20 states that the proceeds of the bonds issued with detachable warrants are allocated between the bonds and the warrants based upon their relative FV at the time of issue. In this case, the portion allocated to the warrants is $10,000, calculated as follows: [$12,000 / ($108,000 + $12,000)] = 10% × $100,000 = $10,000. Therefore, the warrants are recorded at $10,000, and the bonds are recorded at $90,000.
Glen Corporation had the following long-term debt:
Sinking fund bonds, maturing in installments $1,100,000
Industrial revenue bonds, maturing in installments 900,000
Subordinated bonds, maturing on a single date 1,500,000
The total of the serial bonds amounted to
$1,500,000
$2,000,000
$2,400,000
$3,500,000
$2,000,000
This answer is correct. Serial bonds are bond issues that mature in installments. Therefore, the total of the serial bonds is $2,000,000 ($1,100,000 + $900,000). The bonds which mature on a single date ($1,500,000) are called term bonds.
Simms Corporation reports under IFRS. Simms issued 2,000 $1,000 convertible bonds at par, with an annual interest rate of 5% when the market was 8%. The bonds are due in 5 years and each $1,000 bond is convertible into 3 shares of common stock. At what amount would Simms record the equity component of the bond? $6,000 $239,569 $1,760,431 $2,000,000
$239,569
This answer is correct. Under IFRS, convertible debt must be separated into its debt and equity components. To do this, discount the bond at market interest rates as in US GAAP. The liability component is the discounted amount and the equity component is the residual of the cash received less the discounted amount. Calculations are as follows:
Face amount of the bonds: 2,000 × $1,000 = $2,000,000
Present value of $1 for the principal ($2,000,000 × 0.68058) = $ 1,361,160
Present value of an ordinary annuity for the interest ($100,000 × 3.99271) = $ 399,271
Value of the liability = $ 1,760,431
Value of the equity ($2,000,000 – $1,760,431) = $ 239,569
Journal entry at issuance:
Cash $2,000,000
Bonds Payable $1,760,431
Equity – conversion option $239,569
How would the amortization of discount on bonds payable affect each of the following?
Carrying value of bond Net income
increase Decrease
Increase Increase
Decrease Decrease
Decrease Increase
increase Decrease
This answer is correct. The solutions approach is to make the entry necessary to record the amortization of the discount.
Interest expense xxx
Discount on bonds payable xxx
Recall that the discount on bonds payable account usually carries a debit balance that reduces the carrying value of the bonds. This answer is correct because the credit to the discount account increases the carrying value of the bond, and the debit to interest expense will decrease net income.
On January 1, year 1, Weaver Company purchased as a long-term investment $500,000 face value of Park Corporation’s 8% bonds for $456,200. The bonds were purchased to yield 10% interest. The bonds mature on January 1, year 7, and pay interest annually on January 1. Weaver intends to hold the bonds until their scheduled maturity. Weaver uses the interest method of amortization and does not elect the fair value option for reporting financial assets. What amount should Weaver report on its December 31, year 1 balance sheet as long-term investment? $450,580 $456,200 $461,820 $466,200
$461,820
This answer is correct. Held-to-maturity investments should be reported at amortized cost on the balance sheet. The carrying value of long-term investments on December 31, year 1, will be the carrying value on January 1, year 1, plus the discount amortization. Discount amortization is the difference between interest revenue and interest receivable. Interest revenue is the book value of the bonds times the yield rate of interest ($456,200 × .10 = $45,620). Interest receivable is the face value of the bonds times the face rate of interest ($500,000 × .08 = $40,000). The adjusting entry on December 31, year 1, will be
Interest receivable 40,000
Bond investment (long-term) 5,620
Interest revenue 45,620
Thus, the carrying value of the bonds on December 31, year 1, is $461,820 ($456,200 + $5,620). The above entry assumes that the bonds were recorded net when purchased. If a discount of $43,800 was recorded, the $5,620 debit would be to the discount account.
Which of the following is generally associated with the terms of convertible debt securities?
An interest rate that is lower than nonconvertible debt.
An initial conversion price that is less than the market value of the common stock at time of issuance.
A noncallable feature.
A feature to subordinate the security to nonconvertible debt.
An interest rate that is lower than nonconvertible debt.
This answer is correct because convertible debt generally will have an interest rate that is lower than nonconvertible debt.
Under IFRS, convertible bonds issued are
Recorded at face value without consideration of a premium or discount.
Separated into debt and equity components with the liability component recorded at fair value and the residual assigned to the equity component.
Always recorded using the fair value option.
Recorded at face value for the liability along with the associated premium or discount
Separated into debt and equity components with the liability component recorded at fair value and the residual assigned to the equity component.
This answer is correct. Convertible bonds are separated into debt and equity components with the liability component recorded at fair value and the residual assigned to the equity component. The fair value election may be made for the financial liability component.
Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record? $302,000 $325,000 $348,000 $798,000
$302,000
Bonds are converted using the book value method. This answer is correct because the entry to record the conversion is
Bonds 775,000
Discount 23,000
Common stock (90,000 × $5) 450,000
Paid-in capital (plug) 302,000
How would the amortization of premium on bonds payable affect each of the following?
Carrying value of bond Net income
Increase Decrease
Increase Increase
Decrease Decrease
Decrease Increase
Decrease Increase
This answer is correct. When the premium on bonds payable is amortized, the following entry is made:
Premium on bonds payable xxx
Interest expense xxx
This entry has several effects. First, it reduces the amount of the premium. Because the carrying value of the bonds is the face value of the bonds plus the unamortized premium, amortization of the premium serves to reduce the carrying value. Second, amortization of the premium decreases interest expense, thus increasing net income.
On March 1, year 1, Williams Corporation issued at 103 plus accrued interest, 100 of its 9%, $1,000 bonds. The bonds are dated January 1, year 1, and mature on January 1, year 11. Interest is payable semiannually on January 1 and July 1. Williams paid bond issue costs of $5,000. Based on the information above, Williams would realize net cash receipts from the bond issuance of $ 98,000 $ 99,500 $103,000 $104,500
$ 99,500
his answer is correct. $100,000 of bonds are issued at 103 plus accrued interest (2 months, from January 1 to March 1) less bond issue costs of $5,000. The cash received for the bonds is 103% of $100,000, or $103,000. The cash received for the accrued interest is $1,500 ($100,000 × 9% × 2/12). Therefore, cash receipts total $99,500 ($103,000 + $1,500 – $5,000).
itt Corp. has outstanding at December 31, year 1, two long-term borrowings with annual sinking fund requirements and maturities as follows:
Sinking fund
requirements Maturities
year 1 $1,000,000 $ –
year 2 1,500,000 2,000,000
year 3 1,500,000 2,000,000
year 4 2,000,000 2,500,000
year 5 2,000,000 3,000,000
$8,000,000 $9,500,000
In the notes to its December 31, year 1 balance sheet, how should Witt report the above data?
No disclosure is required.
Only sinking fund payments totaling $8,000,000 for the next 5 years detailed by year need be disclosed.
Only maturities totaling $9,500,000 for the next 5 years detailed by year need to be disclosed.
The combined aggregate of $17,500,000 of maturities and sinking fund requirements detailed by year should be disclosed.
The combined aggregate of $17,500,000 of maturities and sinking fund requirements detailed by year should be disclosed.
This answer is correct. ASC Topic 440 requires disclosure at the balance sheet date of future payments for sinking fund requirements and maturity amounts of long-term debt during each of the next 5 years. Therefore, the combined aggregate of $17,500,000 of maturities and sinking fund requirements detailed by year should be disclosed.
Simms Corporation reports under IFRS. Simms issued 2,000 $1,000 convertible bonds, with an annual interest rate of 5% when the market was 8%. The bonds are due in 5 years and each $1,000 bond is convertible into 3 shares of common stock. At what amount would Simms record the liability component of the bond? $ 239,569 $1,760,431 $2,000,000 $2,006,000
$1,760,431
This answer is correct. Under IFRS, convertible debt must be separated into its debt and equity components. To do this, discount the bond at market interest rates as in US GAAP. The liability component is the discounted amount and the equity component is the residual of the cash received less the discounted amount. Calculations are as follows:
Face amount of the bonds: 2,000 × $1,000 = $2,000,000
Present value of $1 for the principal ($2,000,000 × 0.68058) = $ 1,361,160
Present value of an ordinary annuity for the interest ($100,000 × 3.99271) = $ 399,271
Value of the liability = $ 1,760,431
Value of the equity ($2,000,000 – $1,760,431) = $ 239,569
Journal entry at issuance:
Cash $2,000,000
Bonds Payable $1,760,431
Equity – conversion option $239,569
Which of the following statements characterizes convertible debt?
The holder of the debt must be repaid with shares of the issuer’s stock.
No value is assigned to the conversion feature when convertible debt is issued.
The transaction should be recorded as the issuance of stock.
The issuer’s stock price is less than market value when the debt is converted.
No value is assigned to the conversion feature when convertible debt is issued.
This answer is correct because ASC Topic 470 provides that when convertible debt is issued, no value is assigned to the conversion feature.
Ray Finance, Inc. issued a 10-year, $100,000, 9% note on January 1, year 1. The note was issued to yield 10% for proceeds of $93,770. Ray did not elect the fair value option to report financial liabilities. Interest is payable semiannually. The note is callable after 2 years at a price of $96,000. Due to a decline in the market rate to 8%, Ray retired the note on December 31, year 6. On that date, the carrying amount of the note was $94,582, and the discounted market rate was $105,280. What amount should Ray report as gain (loss) from retirement of the note for the year ended December 31, year 6? $ 9,280 $ 4,000 $(2,230) $(1,418)
$(1,418)
This answer is correct. The gain (loss) from retirement of debt is the difference between the cash paid to retire the debt ($96,000) and the debt’s carrying amount ($94,582). The excess cash paid ($96,000 – $94,582 = $1,418) is recognized as a loss from retirement.
Loss 1,418 Notes payable 100,000 Disc. on NP 5,418 (100,000 – 94,582) Cash 96,000 The original proceeds ($93,770) and the present value of the note discounted at the current market rate ($105,280) do not affect the computation of gain (loss) on retirement.
