Bonds Payable and Other Long-term Liabilities
Easy Practice Test
Financial Accounting
Bonds Payable and Other Long-term Liabilities
Easy Practice Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. When a company issues a bond, a contract (indenture) is prepared which states all of the following except:
a. the stated interest rate
b. the market interest rate
c. maturity value
d. maturity date
Answer
2. Bonds payable is usually classified on the balance sheet as
a. a current liability
b. a long-term liability
c. stockholder’s equity
d. long term asset
Answer
The periodic payment does not reduce the amount owed.
3. The entry made to record effective interest incurred will
a. decrease interest expense
b. increase interest expense
c. decrease cash
d. decrease bonds payable
Answer
4. On the maturity date, the company will
a. record the total interest expense related to the bond
b. record the discount or premium on the bond
c. repay the maturity value to the investor
d. repay the principle plus all interest incurred on the bond
Answer
5. The company issuing the bond will receive less than face value if
a. the stated rate is equal to the market rate
b. the stated rate is less than the market rate
c. the stated rate is more than the market rate
d. par value is not equal to face value
Answer
6. A company issued a 100,000, 8%, 5-year bond. The cash exchanged on the date of issue was $104,000. The total amount of interest the company will pay is
a. $8,000
b. $41,600
c. $40,000
d. $44,000
Answer
7. A company issued an $80,000, 10% 10-year bond at a price of 104 when the market rate of interest was 9%. The amount of cash received by the company at issuance is
a. $80,000
b. $72,000
c. $83,200
d. $88,000
Answer
8. The definition of premium or discount is
a. the difference in cash received and the bond price
b. the difference in cash received and the effective interest rate
c. the difference in cash received and the maturity value of the bond
d. the amount of cash received form issuing the bond
Answer
9. A company issued a $150,000 bond with a stated interest rate of 6% when the effective market yield is 8%. The amount of cash the company received is
a. $150,000
b. less than $150,000
c. more than $150,000
d. $21,000
Answer
10. Periodic payments made to repay long term notes payable
a. repay principle only
b. repay interest only
c. repay principle and interest
d. are only made on the maturity date
Answer
C. A note payable requires the same amount to be repaid periodically until the note is paid in full. Interest is paid as it is incurred, so part of the payment goes to pay the interest and the rest of the payment reduces the principle of the note payable.
Remember:
Maturity date is the date the bond liability is repaid
Maturity value is the amount that is repaid at maturity
Issued at a Discount –
Less cash is received than maturity value, effective rate is higher than the stated rate. Interest expense is higher than cash paid
Issued at a Premium –
More cash is received than maturity value, effective rate is lower than stated rate. Interest expense is lower than cash paid
Issue at Par:
Stated rate = cash paid
Effective market rate = interest expense
11. The company issued 100,000, 5 year, 8% bonds at par at the beginning of the current year. Interest is paid on January 1st and July 1st of each year.
A. Prepare the amortization schedule for the bond for the first two payments.
B. Record the issuance of the bond and the first and second interest payments.
Answer
A. First: Determine the amount of cash that will be paid each period –
Maturity Value x stated rate
# payments per year
$100,000 x .08 = $4,000
2 per year
Par means that the amount of cash received is the same as the maturity value and
the effective market interest rate is equal to the stated rate
8%/2=4% Effective 8%/2=4% Premium/ Carrying Interest % Stated % Difference Discount Value 1/1 100,000 7/1 4,000 4,000 0 0 100,000 1/1 4,000 4,000 0 0 100,000
B. Issue the bond:
Cash 100,000 Bond Payable 100,000 First and second interest payments – the same journal entry is used Interest Expense 4,000 Interest Payable 4,000
When a bond is issued at par value there is no discount or premium because there is no difference in the interest expense incurred (market) and the cash paid for interest (stated)
12. The company issued a 10%, 10-year bond with a face value of $100,000 for $113,592 on January 1st of the current year. The market rate of interest at the time of issuance was 8%. Interest is paid on January 1st and July 1st.
A. Prepare the amortization schedule for the bond
B. Record the issuance of the bond and first and second interest payments.
C. What is the amount of bonds payable that will be reported on the balance sheet at the end of the first year?
D. What is the total interest expense that will be reported for the first year?
Answer
First determine the cash paid each period:
Maturity Value x stated rate
# payments per year
$100,000 x .10
2 each year = $5,000
Put $5,000 in the stated column for all periods
Second Compute the amount in the effective interest column.
Prior period carrying value amount x market %
# payments per year
The premium or discount = maturity value – cash received (bond price)
The carrying value (amount owed) column always starts with the cash exchanged
8%/2=4% Effective 10%/2=5% Premium/ Carrying Interest % Stated % Difference Discount Value 1/1 13,592 113,592 7/1 4,544 5,000 456 13,136 113,136 1/1 4,525 5,000 475 12,661 112,661
B. Issue the bond:
Cash 113,592 Bond Payable 100,000 Premium 13,592 First and second interest payments – the same journal entry, different numbers 1st Interest Expense 4,544 Premium 456 Cash 5,000 2nd Interest Expense 4,525 Premium 475 Interest payable 5,000
Interest is accrued on 12/31 because interest was incurred during the period ended 12/31 and not paid until the next year on 1/1.
C. $112,661 The amount in the carrying value column is the amount that will be reported for the Bonds payable on the balance sheet. Most companies do not show the premium part separate. The amount reported is the maturity value plus the premium.
The interest expense and adjustment to premium for the last 6 months of the year
will be recorded on December 31st, the company’s year end.
D. Total interest expense for the year is the first period plus the second period. The two six-month periods are equal to the full year interest expense incurred.
4,544 + 4,525 = 9,069 interest expense for the first year
When a bond is issued at par value there is no discount or premium because there is no difference in the interest expense incurred (market) and the cash paid for interest (stated)
13. The company issued a 10%, 5-year bond with a face value of $200,000 for $192,608. The market rate of interest at the time of issuance was 11%. Interest is paid on January 1st.
A. Prepare the amortization schedule for the bond
B. Record the first and second interest payments.
C. What is the amount of bonds payable that will be reported on the balance sheet at the end of the second year?
D. What is the total amount of cash that will be paid for interest over the life of the bond?
E. What is the total amount of interest expense that will be recorded over the life of the bond?
Answer
A. First determine the cash paid each period:
Maturity Value x stated rate
# payments per year
$200,000 x .10
1 each year = $20,000
The same amount goes in the stated column for all periods
The amount that goes in the effective interest column is computed:
Prior period carrying value amount x market %
# payments per year
The premium or discount = maturity value – cash received (bond price)
The carrying value (amount owed) column always starts with the cash exchanged
(11% / 1) Effective (10 % / 1) Premium/ Carrying Interest % Stated % Difference Discount Value 1/1 7,392 192,608 1/1 21,187 20,000 1,187 6,205 193,795 1/1 21,317 20,000 1,317 4,888 195,112
B. Issue the bond:
Cash 192,608 Discount 7,392 Bond Payable 200,000 First and second interest payments – the same journal entry, different numbers 1st Interest Expense 21,187 Discount 1,187 Cash (interest payable) 20,000 2nd Interest Expense 21,317 Discount 1,317 Interest payable 20,000
Interest is accrued on 12/31 because interest was incurred during the period ended 12/31 and not paid until the next year on 1/1.
C. On the balance sheet at the end of the 2nd year:
195,112
Carrying value at the end of the second annual payment period
D. Total amount of cash paid is equal to annual interest paid x number of years:
$20,000 paid each year x 5 years = $100,000 total cash paid
E. Interest expense for the life of the bond is total cash paid plus the discount. A discount means that interest incurred is higher than cash paid.
Cash Paid each year 20,000
x # of years x 5
Total cash paid 100,000
+ discount 7,392
Total interest expense 107,392
14. The company borrowed $50,000 at an annual rate of 10%, agreeing to pay $15,775 at the end of each year for 4 years.
A. Make the entry to record the borrowing
B. Prepare the amortization schedule for all years
C. Record the payment of the first two payments
D. What will be reported on the balance sheet at the end of the 2nd year?
E. What is the amount of interest expense that will be reported for the 2nd year?
Answer
A.
Cash 50,000
L/T Notes Payable 50,000
B. The amortization schedule determines interest expense each period and the amount owed at the end of each period.
10% Carrying Value Payment Interest Difference (Notes Payable) 50,000 15,775 5,000 10,775 39,225 15,775 3,923 11,852 27,373 15,775 2,737 13,038 14,335 15,775 1,440** 14,335 0 ** Interest must be adjusted due to rounding
C. Record payments made on the notes payable:
1st Notes Payable 10,775 Interest Expense 5,000 Cash 15,775 2nd Notes Payable 11,852 Interest Expense 3,923 Cash 15,775
D. The company will report that $27,373 is owed on the note payable at the end of
two years.
E. Interest expense incurred the second year is $3,923.