Chapter 14

Homework
Student Name: ID

Question # 1

Whiteside Corporation issues $500,000 of 9% bonds, due in 10 years, with interest payable
semiannually. At the time of issue, the market rate for such bonds is 10%.

Compute the issue price of the bonds.

Answer:

Present value of the principal

$500,000 X .37689 .................................................................................. $188,445
Present value of the interest payments
$22,500 X 12.46221 ................................................................................ 280,400
Issue price ..................................................................................... $468,845

Question # 2

On January 1, 2011, JWS Corporation issued $600,000 of 7% bonds, due in 10 years. The bonds were issued
for $559,224, and pay interest each July 1 and January 1. JWS uses the effective-interest method. Prepare
the company's journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the
December 31 adjusting entry.

Assume an effective interest rate of 8%.

Answer

(a) Cash 559,224

Discount on Bonds Payable 40,776
Bonds Payable 600,000

(b) Interest Expense 22,369

Cash 21,000
Discount on Bonds Payable 1,369
($559,224 X 8% X 6/12 = $22,369)
($600,000 X 7% X 6/12 = $21,000)

(c) Interest Expense 22,424

Interest Payable 21,000
Discount on Bonds Payable
559,224 + 1,369 = 560,593
($560,593 X 8% X 6/12 = $22,424) 1,424
Question # 3

Teton Corporation issued $600,000 of 7% bonds on November 1, 2011, for $644,636. The bonds were
dated November 1, 2011, and mature in 10 years, with interest payable each May 1 and November 1.
Teton uses the effective-interest method with an effective rate of 6%.

Prepare Teton's December 31, 2011, adjusting entry.

Answer

Interest Expense 6,446

Premium on Bonds Payable 554
Interest Payable 7,000
($644,636 X 6% X 2/12 = $6,446)
($600,000 X 7% X 2/12 = $7,000)

Question # 4

Foreman Company issued $800,000 of 10%, 20-year bonds on January 1, 2011, at 102. Interest is
payable semiannually on July 1 and January 1. Foreman Company uses the straight-line method of
amortization for bond premium or discount.

Instructions
Prepare the journal entries to record the following.
(a) The issuance of the bonds.
(b) The payment of interest and the related amortization on July 1, 2011.
(c) The accrual of interest and the related amortization on December 31, 2011.
Answer

(a) 1/1/11 Cash ($800,000 X 102%) 816,000

Bonds Payable 800,000
Premium on Bonds Payable 16,000

(b) 7/1/11 Interest Expense 39,600

Premium on Bonds Payable $16,000 /40 400
($16,000 ÷ 40)
Cash ($800,000 X10% X6/12) 40,000

(c) 12/31/11 Interest Expense 39,600

Premium on Bonds Payable 400
Interest Payable 40,000

2|Page
Question # 5

Spencer Company sells 10% bonds having a maturity value of $3,000,000 for $2,783,724. The
bonds are dated January 1, 2010, and mature January 1, 2015. Interest is payable annually on
January 1.

Instructions
1- Set up a schedule of interest expense and discount amortization under the straight-line
method.
2- Set up a schedule of interest expense and discount amortization under the effective-
interest method assuming the interest 12%
Answer

Schedule of Discount Amortization

Straight-Line Method
Carrying
Cash Paid Interest Discount Amount of
Year Expense Amortized Bonds
Jan. 1, 2010 $2,783,724.00
Dec. 31, 2010 $300,000 $343,255.20 $43,255.20* 2,826,979.20
Dec. 31, 2011 300,000 343,255.20 43,255.20 2,870,234.40
Dec. 31, 2012 300,000 343,255.20 43,255.20 2,913,489.60
Dec. 31, 2013 300,000 343,255.20 43,255.20 2,956,744.80
Dec. 31, 2014 300,000 343,255.20 43,255.20 3,000,000.00
*$43,255.20 = ($3,000,000 – $2,783,724) ÷ 5.

Schedule of Discount Amortization

Effective-Interest Method (12%)
Carrying Amount
Cash Paid Interest Discount of Bonds
Year Expense Amortized
(1) (2) (3) (4)
Jan. 1, 2010 $2,783,724.00
Dec. 31, 2010 $300,000 $334,046.88 * $34,046.88 2,817,770.88
Dec. 31, 2011 300,000 338,132.51 38,132.51 2,855,903.39
Dec. 31, 2012 300,000 342,708.41 42,708.41 2,898,611.80
Dec. 31, 2013 300,000 347,833.42 47,833.42 2,946,445.22
Dec. 31, 2014 300,000 353,554.78 ** 53,554.78 3,000,000.00

*$334,046.88 = $2,783,724 X .12.

**Rounded.

3|Page
Question # 6

E14-1 (L01) (Classification of Liabilities) Presented below are various account balances of K.D. Lang Inc.
(a) Unamortized premium on bonds payable, of which $3,000 will be amortized during the next year.
(b) Bank loans payable of a winery, due March 10, 2021. (The product requires aging for 5 years before sale.)
(c) Serial bonds payable, $1,000,000, of which $200,000 are due each July 31.
(d) Amounts withheld from employees’ wages for income taxes.
(e) Notes payable due January 15, 2020.
(f) Credit balances in customers’ accounts arising from returns and allowances after collection in full of account.
(g) Bonds payable of $2,000,000 maturing June 30, 2018.
(h) Overdraft of $1,000 in a bank account. (No other balances are carried at this bank.)
(i) Deposits made by customers who have ordered goods.

Instructions
Indicate whether each of the items above should be classified on December 31, 2017, as a current liability, a long-
term liability, or under some other classification. Consider each one independently from all others; that is, do not
assume that all of them relate to one particular business. If the classification of some of the items is doubtful,
explain why in each case.

Answer:

(a) Valuation account relating to the long-term liability, bonds payable (sometimes referred to as an
adjunct account). The $3,000 would continue to be reported as long-term.
(b) Current liability if current assets are used to satisfy the debt.
(c) Current liability, $200,000; long-term liability, $800,000.
(d) Current liability.
(e) Probably noncurrent, although if operating cycle is greater than one year and current assets are
used, this item would be classified as current.
(f) Current liability.
(g) Current liability unless (a) a fund for liquidation has been accumu-lated which is not classified as
a current asset or (b) arrangements have been made for refinancing.
(h) Current liability.
(i) Current liability.

4|Page
Question # 7

E14-2 (L01) (Classification) The following items are found in the financial statements.
(a) Discount on bonds payable.
(b) Interest expense (credit balance).
(c) Unamortized bond issue costs.
(d) Gain on repurchase of debt.
(e) Mortgage payable (payable in equal amounts over next 3 years).
(f) Debenture bonds payable (maturing in 5 years).
(g) Notes payable (due in 4 years).
(h) Premium on bonds payable.
(i) Bonds payable (due in 3 years)

Instructions
Indicate how each of these items should be classified in the financial statements

Answer:

(a) Discount on bonds payable—Contra account to bonds payable on balance sheet.

(b) Interest expense (credit balance)—Reclassify to interest payable on balance sheet.

(c) Unamortized bond issue costs—Classified as part of long-term liabilities on balance sheet.

(d) Gain on repurchase of debt—Classify as part of other gains and losses on the income statement.

(e) Mortgage payable—Classify one-third as current liability and the remainder as long-term liability
on balance sheet.
(f) Debenture bonds—Classify as long-term liability on balance sheet.

(g) Notes payable—Classify as long-term liability on balance sheet.

(h) Premium on bonds payable—Classify as adjunct account to Bonds payable on balance sheet.

(i) Bonds payable—Classify as long-term liability on balance sheet.

5|Page
Question # 8 True – False Questions

1. Companies usually make bond interest payments semiannually, although the interest rate is generally
expressed as an annual rate. T

2. If the market rate is greater than the coupon rate, bonds will be sold at a premium. F

3. The interest rate written in the terms of the bond indenture is called the effective yield or market rate. F

4. The stated rate is the same as the coupon rate. T

5. Amortization of a premium increases bond interest expense, while amortization of a discount decreases
bond interest expense. F

6. A bond may only be issued on an interest payment date. F

7. The cash paid for interest will always be greater than interest expense when using effective-interest
amortization for a bond. F

8. Bond issue costs are capitalized as a deferred charge and amortized to expense over the life of the bond
issue. T

9. The replacement of an existing bond issue with a new one is called refunding. T

10. If a long-term note payable has a stated interest rate, that rate should be considered to be the effective
rate. F

11. The debt to total assets ratio will go up if an equal amount of assets and liabilities are added to the
balance sheet. T

12. The times interest earned ratio is computed by dividing income before interest expense by interest
expense. F

Question # 9 Multiple Choice Questions (Conceptual)

1. The covenants and other terms of the agreement between the issuer of bonds and the lender are set
forth in the
a. bond indenture.
b. bond debenture.
c. registered bond.
d. bond coupon.

6|Page
2. The term used for bonds that are unsecured as to principal is
a. junk bonds.
b. debenture bonds.
c. indebenture bonds.
d. callable bonds.

3. Bonds for which the owners' names are not registered with the issuing corporation are called
a. bearer bonds.
b. term bonds.
c. debenture bonds.
d. secured bonds.

4. If bonds are issued initially at a premium and the effective-interest method of amortization is used,
interest expense in the earlier years will be
a. greater than if the straight-line method were used.
b. greater than the amount of the interest payments.
c the same as if the straight-line method were used.
d. less than if the straight-line method were used.

5. The interest rate written in the terms of the bond indenture is known as the
a. coupon rate.
b. nominal rate.
c. stated rate.
d. coupon rate, nominal rate, or stated rate.

6. The rate of interest actually earned by bondholders is called the

a. stated rate.
b. yield rate.
c. effective rate.
d. effective, yield, or market rate.

Use the following information for questions 7 and 8:

Fox Co. issued $100,000 of ten-year, 10% bonds that pay interest semiannually. The bonds are sold
to yield 8%.

7. One step in calculating the issue price of the bonds is to multiply the principal by the table
value for
a. 10 periods and 10% from the present value of 1 table.
b. 20 periods and 5% from the present value of 1 table.
c. 10 periods and 8% from the present value of 1 table.
d. 20 periods and 4% from the present value of 1 table.

7|Page
8. Another step in calculating the issue price of the bonds is to
a. multiply $10,000 by the table value for 10 periods and 10% from the present value of an
annuity table.
b. multiply $10,000 by the table value for 20 periods and 5% from the present value of an
annuity table.
c. multiply $10,000 by the table value for 20 periods and 4% from the present value of an
annuity table.
d. none of these.

9. If bonds are initially sold at a discount and the straight-line method of amortization is used, interest
expense in the earlier years will
a. exceed what it would have been had the effective-interest method of amortization been
used.
b. be less than what it would have been had the effective-interest method of amortization been
used.
c. be the same as what it would have been had the effective-interest method of amortiza-tion
been used.
d. be less than the stated (nominal) rate of interest.

10. Under the effective-interest method of bond discount or premium amortization, the periodic interest
expense is equal to
a. the stated (nominal) rate of interest multiplied by the face value of the bonds.
b. the market rate of interest multiplied by the face value of the bonds.
c. the stated rate multiplied by the beginning-of-period carrying amount of the bonds.
d. the market rate multiplied by the beginning-of-period carrying amount of the bonds.

11. When the effective-interest method is used to amortize bond premium or discount, the periodic
amortization will
a. increase if the bonds were issued at a discount.
b. decrease if the bonds were issued at a premium.
c. increase if the bonds were issued at a premium.
d. increase if the bonds were issued at either a discount or a premium.

12. The times interest earned ratio is computed by dividing

a. net income by interest expense.
b. income before taxes by interest expense.
c. income before income taxes and interest expense by interest expense.
d. net income and interest expense by interest expense.

13. The debt to total assets ratio is computed by dividing

a. current liabilities by total assets.
b. long-term liabilities by total assets.
c. total liabilities by total assets.
d. total assets by total liabilities.

8|Page
Question # 10

Use the following information for questions 1 through 3:

On January 1, 2010, Ellison Co. issued eight-year bonds with a face value of $1,000,000 and a stated
interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield 8%.
Table values are:
Present value of 1 for 8 periods at 6% .627
Present value of 1 for 8 periods at 8% .540
Present value of 1 for 16 periods at 3% .623
Present value of 1 for 16 periods at 4% .534
Present value of annuity for 8 periods at 6% 6.210
Present value of annuity for 8 periods at 8% 5.747
Present value of annuity for 16 periods at 3% 12.561
Present value of annuity for 16 periods at 4% 11.652

1. The present value of the principal is

a. $534,000. $1,000,000 × .534 = $534,000
b. $540,000.
c. $623,000.
d. $627,000.

2. The present value of the interest is

a. $344,820.
b. $349,560. ($1,000,000 × .03) × 11.652 = $349,560.
c. $372,600.
d. $376,830.

3. The issue price of the bonds is

a. $883,560. $534,000 + $349,560 = $883,560
b. $884,820.
c. $889,560.
d. $999,600.

4. Downing Company issues $5,000,000, 6%, 5-year bonds dated January 1, 2010 on January 1, 2010.
The bonds pay interest semiannually on June 30 and December 31. The bonds are issued to yield
5%. What are the proceeds from the bond issue?
2.5% 3.0% 5.0% 6.0%
Present value of a single sum for 5 periods .88385 .86261 .78353 .74726
Present value of a single sum for 10 periods .78120 .74409 .61391 .55839
Present value of an annuity for 5 periods 4.64583 4.57971 4.32948 4.21236
Present value of an annuity for 10 periods 8.75206 8.53020 7.72173 7.36009
a. $5,000,000
b. $5,216,494
c. $5,218,809 ($5,000,000 × .78120) + ($150,000 × 8.75206) = $5,218,809
d. $5,217,308
9|Page
5. Farmer Company issues $10,000,000 of 10-year, 9% bonds on March 1, 2010 at 97 plus accrued
interest. The bonds are dated January 1, 2010, and pay interest on June 30 and December 31. What
is the total cash received on the issue date?
a. $9,700,000
b. $10,225,000
c. $9,850,000 ($10,000,000 × .97) + ($900,000 × 2/12) = $9,850,000.
d. $9,550,000

6. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2010. Interest is
paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using effective-
interest amortization, how much interest expense will be recognized in 2010?
a. $780,000
b. $1,560,000
c. $1,568,498 ($19,604,145 × .04) + ($19,608,310 × .04) = $1,568,498.
d. $1,568,332

10 | P a g e