Bonds Payable and Other Long-term Liabilities
Hard Practice Test
Financial Accounting
Bonds Payable and Other Long-term Liabilities
Hard Practice Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. Which of the following is a reason to issue bonds rather than common stock?
a. interest payments reduce income taxes paid
b. bondholders have more voting rights than common stockholders
c. net income is higher when bonds are issued
d. cash received from bonds will be higher than received from stock
Answer
2. When a bond is sold at a premium, amortization of the premium is
a. an increase to interest expense
b. a decrease to interest expense
c. an increase to the premium
d. an increase to the amount owed
Answer
3. Which is true when a bond is issued at a discount?
a. the amount the discount is reduced is lower each period
b. the amount of interest expense is higher each period
c. the amount of interest expense is lower each period
d. the net amount owed will eventually be less than the discount
Answer
4. The company issued a $10,000, 5-year, 10% bond that pays semiannually. The market rate of interest was 12% at the time of issuance. The interest expense recorded with the first payment will be
a. higher than $500
b. lower than $500
c. equal to $1,000
d. lower than $120
Answer
The cash paid will be $10,000 x .10 / 2 = $500 Interest expense will be higher than the periodic cash payment.
5. When a bond is issued at a lower rate of market interest than the stated rate
a. the cash received is lower than maturity value
b. the cash received is higher than maturity value
c. interest expense will be higher than cash paid
d. the net amount owed at the end of the period will increase with each payment made for interest
Answer
6. The issue price of a 0 stated rate bond will be
a. higher than maturity value
b. lower than maturity value
c. issued at a premium
d. issued at par
Answer
7. When the typical rate earned by an investor for a company of equivalent risk and economic situation is lower than the stated/stated rate, the bond will be issued at
a. an amount less than maturity value
b. an amount greater than maturity value
c. par value
d. a discount
Answer
8. As market interest rates increase, the market price of a bond
a. does not change, it stays at the issue price
b. increases
c. decreases
d. increases at a rate proportionate to the percentage increase in the market rate
Answer
C. When rates are higher, less cash is required to earn the return. The market price of the bond is the cash exchanged. Higher rates decrease the price of a bond. The present value of future cash flows prevents the increase in price from being equal to the % increase in rates (d).
9. A company registered to issue a 10%, 20-year bond when the market rate was 10%. Prior to issuing the bond, market rates increased to 11%. The company must
a. re-register the bond contract
b. expect to receive more cash than was originally planned
c. change the stated interest rate to match the current market rate
d. expect to receive less cash than was originally planned
Answer
10. When the market rate changes after issuing the bond, the company
a. incurs the same rate of interest expense
b. will have interest expense that changes with market rate changes
c. pays a different amount for interest as market rates change
d. both b. & c.
Answer
11. On May 1, 20X0, the Company issued a $500,000, 8%, 5-year bond for $461,834. Interest will be paid on May 1st and November 1st of each year. The market rate on the date of issue was 10%. The market rate at the end of the 1st year and 2nd year was 11% and 11.5% respectively. The company has the option to pay back the bonds early at the end of the 2nd year at a price of $450,000. Fair market value of the bond is $600,000 at the end of the 2nd year.
A. Prepare the amortization schedule for the bond for the first 3 payments
B. Record the issuance of the bond and the third interest payment made.
C. Should the company repay the bond at the end of the 2nd year?
D. What is the total interest expense that should be reported on the income statement for the year 20X0?
Answer
Market rate changes after the bond is issued have no impact on the company.
A. (10% / 2) Effective (MV x 8% /2) Premium/ Carrying Interest % Stated % Difference Discount Value 5/1 38,166 461,834 11/1 23,092 20,000 3,092 35,074 464,926 5/1 23,246 20,000 3,246 31,828 468,172 11/1 23,409 20,000 3,409 28,419 471,581
B. Cash 461,834 Discount 38,166 Bond Payable 500,000 Interest Expense 23,409 Discount 3,409 Cash 20,000
C. The bond can be repaid for $450,000. Fair market value is now $600,000. When the value of the bond goes up, interest rates are lower. The current amount owed is not relevant to the decision to refinance. It is not the amount that would be paid to the holder of the bond. The company should also consider that they will pay $11,834 less to repay the bond than was received. This will be recorded as a gain on the income statement. The company should consider paying this bond off and borrowing at a lower interest rate.
D. Interest expenses reported for 20X0 should be the amount incurred during 20X0:
May 1 to October 31st 23,092 November 1 to December 31 7,749 Total interest expense 30,841 (23,246 x 2 / 6-month period) = $7,749
The amount from November 1 to December 31 has not yet been paid, and must be accrued as interest expense.
12. On January 1, 20X0, the company issued $100,000, 12%, 10-year bonds at a price of $112,463. The market rate of interest was either 10% or 14%; the company accountant can not find the documentation to determine the effective rate. Interest is paid semiannually on January 1 and July 1. The market rate of interest increased after the bonds were issued.
A. Determine the market rate at the date of issuance.
B. Prepare the amortization schedule for the bond for the first 3 payments
C. Record the bond issuance and the first 2 interest payments.
D. What will be reported on the balance sheet dated December 31, 20X0?
E. What will be reported on the 20X0 income statement?
F. Record the entry for early repayment of the bond on June 1, 20X1 for $105,000.
Answer
A. When more cash is received than maturity value, a premium, the effective rate must be lower than the stated rate, therefore, the market rate was 10%. Interest changes after the bond is issued do not change the amortization schedule or affect the company.
B. Amortization schedule:
(10% / 2) Effective (MV x 12% / 2) Premium/ Carrying Interest % Stated % Difference Discount Value 1/1/X0 12,463 112,463 7/1/X0 5,623 6,000 377 12,086 112,086 1/1/X1 5,604 6,000 396 11,690 111,690 7/1/X1 5,585 6,000 415 11,275 111,275
C.
Cash 112,463 Premium 12,463 Bond Payable 100,000 Interest Expense 5,623 Premium 377 Cash 6,000 Interest Expense 5,604 Premium 396 Cash 6,000
D. $111,690 will be the net bond payable reported on the December 31st, 20X0 balance sheet. The carrying value column always shows the amount owed.
E. Interest expense will be the total of the 2, 6-month periods during 20X0.
5,623 + 5,604 = 11,227
F. This is an early repayment of the bond which will lead to a gain or loss. When more is paid than owed, a loss is recorded. When less is paid than owed, a gain is recorded.
Decrease the bond payable and the premium to get them to 0 (nothing is owed).
Record the cash paid as a decrease
Plug the difference to a gain or loss
Bond Payable 100,000 Premium 11,275 Cash 105,000 Gain on early repayment 6,275