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Exam 10: Accounting for Long-Term Debt

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Question 1

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Which of the following describes what happens when bonds are issued when the market interest rate is less than the stated interest rate?

A) The bonds are issued at a premium.
B) The bonds are issued at less than their face value.
C) It raises the effective interest rate above the stated rate of interest.
D) The bonds are issued at a premium and the effective interest rate is higher than the stated rate.

E) B) and D)
F) B) and C)

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Question 2

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Why are bonds sometimes issued at a discount?

A) The stated rate of interest is higher than the rate being paid on investments in the securities market with comparable risk.
B) The stated rate of interest is the same as the rate being paid on investments in the securities market with comparable risk.
C) The stated rate of interest is lower than the rate being paid on investments in the securities market with comparable risk.
D) The bonds are being issued between interest payment dates.

E) All of the above
F) C) and D)

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Question 3

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A discount or premium on bonds payable can be defined by which of the following statements?

On January 1, Year 1, Strang Incorporated issued bonds with a face value of $500,000, a stated rate of interest of 8%, and a 5-year term to maturity. The effective rate of interest was 10%. Interest is payable in cash on June 30 and December 31 of each year. Which of the following statements is true?

Indicate whether each of the following statements about bonds is true or false.a)The carrying value of a bond increases over time if the bond was issued at a premium.b)At the end of the term of the bonds, the carrying value of a bond issue is equal to the issue price.c)If bonds are sold below face value, the difference between the issue price and the face value is called the bond discount.d)The payment of interest is an operating activity on the statement of cash flows.e)The issuance of bonds does not appear on the statement of cash flows.

Marvin Corporation issued $500,000 of 8%, 10-year bonds for 98 on January 1, Year 1. Interest is payable annually on December 31. The company uses the straight-line method to amortize bond discounts and premiums.Required:a)Prepare the liabilities section of the balance sheet at December 31, Year 1.b)Determine the amount of interest expense reported on the Year 1 income statement.c)Prepare the operating activities section of the Year 1 statement of cash flows.

Discuss one advantage of issuing bonds versus borrowing money from a bank.

Why do some bonds sell at a premium? How does a premium impact the effective interest rate?

Indicate whether each of the following statements about bonds payable is true or false.a)A convertible bond may be converted into stock of the issuing company at the option of the bondholder.b)Businesses typically issue bonds to banks to borrow large amounts of cash.c)A debenture is an unsecured bond.d)Callable bonds may be turned in for early retirement at the option of the bondholder.e)The issuer of a bond receives cash when the bond is issued.

If a company has issued bonds at a premium, the amount of interest expense reported on the income statement each year will be greater than the amount of cash paid to bondholders for interest.

The times-interest-earned ratio is calculated by which of the following?

Indicate whether each of the following statements about bonds payable is true or false.a)Premium on Bonds Payable is recorded when bonds are issued at less than their face value.b)Premium on Bonds Payable is a liability account.c)The balance in the Discount on Bonds Payable account increases liabilities.d)Discount on Bonds Payable is an expense account.e)A discount on bonds payable occurs when the stated interest rate on the bonds is less than the market or effective interest.

What is another term used to describe unsecured bonds?

Davis Corporation borrowed $50,000 on January 1, Year 1. The loan is for a 10-year period and has an annual interest rate of 9%. At the end of each year, Davis will make a payment of $7,791, which includes both principal and interest. The amount of the payment for Year 1 that is interest expense is $4,500.

Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts.Increase = I Decrease = D Not Affected = NAOn January 1, Year 1, Ravenwood Company issued a long-term installment note.

Company A and Company B are identical in all regards except that during Year 1 Company A borrowed $40,000 at an interest rate of 10%. In contrast, Company B obtained financing by acquiring $40,000 from sale of common stock. Company B agreed to pay a $4,000 cash dividend each year. Both companies are in a 30% tax bracket. Which company would show the greater retained earnings at the end of Year 1, and by what amount?

Greenwood Company issued bonds with a face value of $150,000, a stated interest rate of 6% bonds, and a 10-year maturity term. Interest is payable in cash on December 31 of each year. The bonds were sold at 103.5. The company uses the straight-line method to amortize bond discounts and premiums.Required:Calculate the amount of annual interest expense

If the stated interest rate for bonds is the same as the effective interest rate, the bonds will be issued at their face value.

How are interest rates normally set for lines of credit?

Which of the following is one of the main advantages of using long-term debt financing instead of equity financing?