Bonds Payable and Other Long-term Liabilities
Medium Practice Test
Introduction to Accounting
Bonds Payable and Other Long-term Liabilities
Medium Practice Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. When the effective yield is higher than the stated rate, the bond will be sold at
a. a discount
b. a premium
c. par
d. maturity value
Answer
2. When a bond is issued at a premium, the stated rate will be
a. equal to the effective rate
b. lower than the effective rate
c. higher than the effective rate
d. a rate that changes with changes in the market rate
Answer
3. When a bond is issued at a discount, interest expense will be
a. higher than the amount of cash paid for interest
b. lower than the amount of cash paid for interest
c. equal to the amount of cash paid for interest
d. lower than the market rate of interest
Answer
4. A company issues a $200,000, 6%, 5-year bond for a price of 96. The total amount of interest expense that will be recorded by the company over the life of the bond is
a. $64,000
b. $56,000
c. $204,000
d. $196,000
Answer
A. The amount paid for interest is always the maturity value x the stated rate. A discount represents additional interest expense over the life of the bond. A premium represents lower interest expense over the life of the bond. Total interest expense is computed as:
Maturity value x stated % = per year x years = interest paid (also an expense)
$200,000 x .06 + $12,000 x 5 = $60,000
+ additional interest expense
not paid until maturity (discount) $ 4,000
Total interest expense $64,000
5. When recording interest related to bonds payable, the company will use the amortization schedule to
a. determine the maturity value of the bond at the end of the period
b. determine the cash interest that will be paid
c. determine the effective interest rate for the period
d. determine the difference in interest expense and cash paid
Answer
6. The difference in long term notes payable and bonds payable is
a. long term notes have a premium or discount and bonds payable do not
b. the interest rate on bonds payable is generally much higher
c. one incurs interest expense periodically and the other does not
d. when principle is repaid
Answer
7. The interest expense incurred on a long-term note payable is always
a. the amount borrowed multiplied by the stated interest rate
b. the amount borrowed multiplied by the effective interest rate
c. the amount owed at the end of last period times the stated interest rate
d. equal to the amount of payment
Answer
The amount owed changes each period as payments are made.
8. The entry to record the issuance of a bond will
a. decrease assets and increase liabilities
b. increase assets and increase liabilities
c. increase interest expense, assets, and liabilities
d. decrease liabilities and assets
Answer
9. When bonds are issued at a discount, the amount reported on the balance sheet as bonds payable is
a. higher than maturity value
b. lower than maturity value
c. always equal to maturity regardless of the issue price
d. always equal to par regardless of the issue price
Answer
10. When bonds are issued at a premium, total interest expense incurred over the life of the bond will
a. be equal to the maturity value of the bond
b. be less than cash paid for interest over the life of the bond
c. be more than cash paid for interest over the life of the bond
d. be equal to cash paid for interest over the life of the bond
Answer
B. The additional amount received (premium) is also the amount that interest expense is less than cash paid for interest. When the company receives more than they have to repay at the end of the term, effective interest is less.
11. On January 1, 20X7, ABC Corporation issued a $500,000 face value, 10% coupon, bond for $541,296, with an annual effective yield of 8 percent. The bonds mature in 10 years. Interest is payable on January 1 and July 1 and the company uses the effective interest method to record interest expense. The company’s fiscal year ends on December 31st of each year. (Round to the nearest $1)
A. Prepare an amortization schedule through July 1, 20X8 ONLY.
B. Prepare the required journal entry for issuing the bonds on January 1, 20X7.
C. Prepare the required journal entry on July 1, 20X8.
E. Determine the total amount of cash that will be paid for interest over the life of the bond.
D. Determine the total amount of interest expense that will be paid over the life of the bond.
Answer
A. (8% / 2) (MV x 10%/2) Effective Coupon or Premium/ Carrying Interest % Stated % Difference Discount Value 1/1/X7 41,296 541,296 7/1/X7 21,652 25,000 3,348 37,948 537,948 1/1/X8 21,518 25,000 3,482 34,466 534,466 7/1/X8 21,379 25,000 3,621 30,845 530,845
B. Issuance of the bond
Cash 541,296
Premium 41,296
Bond Payable 500,000
C. Interest is paid on July 1, 20X8
Interest Expense 21,379
Premium 3,621
Cash 25,000
D. Total interest paid = Interest paid each period x number of payments
$25,000 x 10 years x 2 each year = $500,000 total cash paid
E. Total interest expense = total cash paid less the premium received
$500,000 less $41,296 = $458,704
Notice on the amortization schedule that interest expense is less than cash paid
12. The company issued $250,000, 6%, 10-year bonds at a price of 97.1 at the beginning of the current year. Interest is paid semi-annually. The effective market rate on the date of issuance was 7%. Without preparing an amortization schedule:
A. Determine the amount of cash exchanged when the bonds were issued.
B. Determine the amount of the discount/premium when the bonds were issued.
C. Determine the first year’s interest expense
D. Determine total interest expense over the life of the bonds
E. Determine the total amount of cash that will be paid for interest over the life of the bond.
F. Determine the amount that will be repaid on the maturity date.
G. Determine the amount that will be reported on the balance sheet at the end of the year the bond was issued.
Answer
A. Cash exchanged is computed:
Maturity Value 250,000 x price of bond in a % 0.971 = Cash exchanged 242,750
B. A discount occurs when the cash exchanged is less than maturity value for the difference:
Cash exchanged 242,750 Maturity value 250,000 Discount 7,250
C. The first period interest expense will be the cash exchanged x the effective rate.
The new amount owed (carrying value) must be determined for the second period:
242,750 x .07 / 2 = $8,496
242,750 + (8,496 – 7,500 **)
= 243,746 x .035 = $8,531
Total interest exp 1st year = $17,027
** 250,000 x .06 / 2 = 7,500 cash paid each period
D. Total interest expense over the life of the bond is
cash paid each period 7,500 x number of payments per year x 2 x years to maturity x 10 = total cash paid 150,000 + discount 7,250 = total interest expense 157,250
E. The cash paid over the life of the bond is 150,000, computed in D.
F. The amount that is repaid on the maturity date is the maturity value, $250,000
G. The amount that will be reported on the balance sheet is the amount of the carrying value on that date:
Cash received 242,750 - Cash paid for the year (15,000) + interest expense for the year 17,027 = adjusted amount owed end of year 244,777
$244,777 is reported on Balance Sheet
13. A doctor borrowed $100,000 to establish a practice in a small town on January 1st of the current year. The loan agreement stated the following:
Annual interest rate 8%
# of payments to be made 20
Equal payments are to be made at the end of each quarter
The accountant used the present value table to determine the present value of an annuity for
5 periods at 8% = 3.9927
20 periods at 8% = 9.8182
20 periods at 2% = 16.3514
A. Determine the amount of each payment that must be made quarterly
B. Prepare an amortization schedule for the note for the first 4 payments
C. Record the first two payments made
D. Determine the amount that will be reported for the notes payable at the end of the first year.
E. Determine the total interest expense that will be reported for the first year.
Answer
A.
Amount borrowed
PV factor of annuity
$100,000 = $6,116 each quarter
16.3514
The present value factor should be the factor for the number of total payments that will be made and the annual rate / # payments per year
B. Amortization Schedule to determine interest expense and amount owed at the end of each period.
10%/4=2% Carrying Value Payment Interest Difference (Notes Payable) 1/1 100,000 3/31 6,116 2,000 4,116 95,884 6/30 6,116 1,918 4,198 91,686 9/30 6,116 1,834 4,282 87,404 12/31 6,116 1,748 4,368 83,036
C. Record payments made on the notes payable:
1st Notes Payable 4,116 Interest Expense 2,000 Cash 6,116 2nd Notes Payable 4,198 Interest Expense 1,918 Cash 6,116
D. The company will report that $83,036 is owed on the note payable at the end of
the first year.
E. Interest expense incurred the first year is the total of all amounts in the interest column for this year (2,000 + 1,918 + 1,834 + 1,748) = $7,500.