Chapter 14 Long-Term Financial Liabilities Test Bank Docx - Test Bank Intermediate Accounting v2 13e | Canada by Donald E. Kieso. DOCX document preview.
CHAPTER 14
LONG-TERM FINANCIAL LIABILITIES
CHAPTER STUDY OBJECTIVES
1. Understand the nature of long-term debt financing arrangements. Incurring long-term debt is often a formal procedure. Corporation bylaws usually require the approval of the board of directors and the shareholders before bonds can be issued or other long-term debt arrangements can be contracted. Generally, long-term debt has various covenants or restrictions. The covenants and other terms of the agreement between the borrower and the lender are stated in the bond indenture or note agreement. Notes are similar in substance to bonds but do not trade as readily in capital markets, if at all.
The variety of types of bonds and notes is a result of attempts to attract capital from different investors and risk takers and to satisfy the issuers’ cash flow needs.
External credit rating agencies rate bonds and assign a credit rating based on the riskiness. The credit rating helps investors decide whether to invest in a particular bond. Companies sometimes extinguish debt early using a defeasance arrangement. In a defeasance arrangement, funds are deposited into a trust and the trust continues to make the regularly scheduled payments until maturity.
By using debt financing, companies can maximize income through the use of leverage. Capital-intensive industries often have higher levels of debt. Continued access to low-cost debt is important for maximizing shareholder value.
2. Understand how long-term debt is measured and accounted for. The investment community values a bond at the present value of its future cash flows, which consist of interest and principal. The rate that is used to calculate the present value of these cash flows is the interest rate that provides an acceptable return on an investment that matches the issuer’s risk characteristics. The interest rate written in the terms of the bond indenture and ordinarily appearing on the bond certificate is the stated, coupon, or nominal rate. This rate, which is set by the issuer of the bonds, is expressed as a percentage of the bond’s face value, which is also called the par value, principal amount, or maturity value. If the rate used by the buyers differs from the stated rate, the bond’s present value calculated by the buyers will differ from the bond’s face value. The difference between the bond’s face value and the present value is either a discount or a premium. Long-term debt is measured at fair value on initial recognition, less transaction costs where the instruments will be valued at amortized cost or, in certain limited situations, fair value, under the fair value option.
The discount (premium) is amortized and charged (credited) to interest expense over the period of time that the bonds are outstanding. IFRS requires the effective interest method; however, ASPE allows a choice and smaller private entities often use the straight-line method.
Bonds and notes may be issued with zero interest or for a non-monetary consideration. Measurement of the bonds and the consideration must reflect the underlying substance of the transaction. In particular, reasonable interest rates must be imputed. The fair value of the debt and of the non-monetary consideration should be used to value the transaction.
3. Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings. At the time of reacquisition, the unamortized premium or discount and any costs of issue that apply to the debt must be amortized up to the reacquisition date. The amount that is paid on extinguishment or redemption before maturity, including any call premium and expense of reacquisition, is the reacquisition price. On any specified date, the debt’s net carrying amount is the amount that is payable at maturity, adjusted for unamortized premium or discount and the cost of issuance. Any excess of the net carrying amount over the reacquisition price is a gain from extinguishment, whereas the excess of the reacquisition price over the net carrying amount is a loss from extinguishment. Legal defeasance results in derecognition of the liability. In substance defeasance does not.
Where debt is settled by exchanging the old debt with new debt (generally in troubled debt situations), it is treated as a settlement where the terms of the agreements are substantially different, including a size test, and where the new debt is with a new lender. If not treated as a settlement, it is treated as a modification of the old debt and a new interest rate is imputed under ASPE. Under IFRS, a gain/loss is recognized.
Off–balance sheet financing may represent an attempt to present borrowed funds in such a way that the obligations are not recognized. One type of off–balance sheet financing involves the use of certain variable interest entities. Accounting standard setters are studying this area with the objective of coming up with a new definition of what constitutes the reporting entity.
4. Explain how long-term debt is presented, disclosed, and analyzed. Companies that have large amounts and many issues of long-term debt often report only one amount in the SFP and support this with comments and schedules in the accompanying notes. Long-term debt that matures within one year should be reported as a current liability, unless it will be retired without using current assets. If the debt is to be refinanced, converted into shares, or retired from a bond retirement fund, it should continue to be reported as non-current and accompanied by a note explaining the method to be used in its liquidation unless certain conditions are met.
Note disclosures are significant and generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by the creditors, and assets designated or pledged as security as well as other details.
Debt to total assets and times interest earned are two ratios that provide information about debt-paying ability and long-term solvency.
5. Identify major differences in accounting standards between IFRS and ASPE, and what changes are expected in the near future. IFRS and ASPE are largely similar with regard to long-term debt. Small differences relate to whether the debt is presented as current or non-current and to measurement. For example, ASPE has measurement standards for related party transactions. The standard setters have been working several large projects, including the conceptual framework and financial instruments with the characteristics of equity.
Multiple Choice QUESTIONS
Answer No. Description
a 1. Liability identification
b 2. Restrictions in restricted covenants
d 3. Bond vocabulary
c 4. Bond vocabulary
c 5. Bond vocabulary
b 6. Convertible bond
a 7. Commodity-backed bond
d 8. Rate of interest earned by bondholders
b 9. Bond premium and interest rates
a 10. Interest and discount amortization
b 11. Effective interest amortization method
d 12. Impact of effective interest method
c 13. Bonds issued between interest dates
d 14. Bonds issued between interest dates
b 15. Valuation of bonds
d 16. Bond face value
b 17. Notes with zero interest or non-monetary consideration
d 18. Fair value option
d 19. Note issued for property, goods, or services
a 20. Calculate the present value of bond principal
a 21. Calculate the present value of bond interest
a 22. Calculate the issue price of bonds
b 23. Interest expense using effective interest method
c 24. Interest expense using effective interest method
a 25. Interest on non–interest-bearing note
c 26. Interest on instalment note payable
a 27. Calculate balance of note payable
c 28. Calculate proceeds from bond issue
b 29. Calculate balance in bonds payable account
c 30. Calculate balance in bonds payable account
b 31. Calculate bond interest expense
b 32. Bonds trading at a discount
b 33. Straight-line interest amortization method
a 34. Comparison of IFRS and ASPE
c 35. Callable bonds
a 36. Debt refunding
c 37. Modification of terms in troubled debt restructuring
d 38. Gain/loss on troubled debt restructuring
b 39. Gain/loss on troubled debt restructuring
c 40. Creditor's calculations for modification of terms
d 42. Off-balance-sheet financing
b 43. Calculate gain on retirement of bonds
Answer No. Description
a 44. Calculate gain or loss on retirement of bonds
c 45. Calculate loss on retirement of bonds
b 46. Bond retirement with call premium
b 47. Calculate loss on retirement of bonds
b 48. Transfer of equipment in debt restructure
d 49. Recognizing gain on debt restructure
b 50. Interest and troubled debt restructuring
b 51. Calculate loss on retirement of bonds
a 52. Calculate loss on retirement of bonds
b 53. Calculate gain or loss on retirement of bonds
c 54. Calculate gain or loss on retirement of bonds
d 55. Classification of gains from troubled debt restructuring
d 56. In-substance defeasance
c 57. Off-balance-sheet financing
a 58. Presentation
b 59. Presentation
b 60. Long-term debt disclosures
d 61. Disclosure
b 62. Disclosure
c 63. Times interest earned ratio
a 64. Debt to total assets ratio
d 65. Times interest earned ratio
b 66. Debt to total assets ratio
d 67. Calculate times interest earned ratio
c 68. Calculate debt to total assets ratio
b 69. Calculate times interest earned ratio
b 70. Calculate debt to total assets ratio
b 71. Comparison of IFRS and ASPE
a 72 Restructuring of debt with no substantial modification
Exercises
Item Description
E14-73 Underwriting for bond issues
E14-74 Terms related to long-term debt
E14-75 Amortization of premium
E14-76 Bond issue price and premium amortization
E14-77 Amortization of discount
E14-78 Bond issue price and discount amortization
E14-79 Note issued for cash and other rights
E14-80 Note issued for non-cash consideration
E14-81 Sale and subsequent buyback of bonds
E14-82 Entries for bonds payable
E14-83 Repayment of bond before maturity
E14-84 Retirement of bonds
E14-85 Early extinguishment of debt and bond redemptions
E14-86 Accounting for a troubled debt settlement
E14-87 Accounting for a troubled debt restructuring
E14-88 Accounting for troubled debt
PROBLEMS
Item Description
P14-89 Bond interest and premium amortization
P14-90 Bond interest and premium amortization
P14-91 Bond interest and discount amortization
P14-92 Bond interest and discount amortization
P14-93 Fair value option and calculation
P14-94 Entries for bonds payable
P14-95 Entries for bonds payable
P14-96 Accounting for bond issuance and gain on retirement
P14-97 Accounting for bond issuance and loss on retirement
P14-98 Bond accounting, ratios, debt covenants
P14-99 Accounting for a troubled debt settlement
MULTIPLE CHOICE QUESTIONS
1. Which of the following is NOT generally classified as a long-term liability?
a) stock dividends distributable
b) pension liabilities
c) mortgages payable
d) lease liabilities
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
2. Restrictions included in restricted covenants do NOT generally include
a) working capital restrictions.
b) limits on executive compensation.
c) dividend restrictions.
d) limitations on incurring additional debt.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
3. A contract representing the covenants and other terms of the agreement between the issuer of bonds and the lender is known as a
a) bond debenture.
b) long-term note payable.
c) registered bond.
d) bond indenture.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
4. The term used for bonds that are backed by collateral is
a) convertible bonds.
b) debenture bonds.
c) secured bonds.
d) callable bonds.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
5. Bonds frequently used by schools and municipalities that mature in instalments are called
a) convertible bonds.
b) revenue bonds.
c) serial bonds.
d) callable bonds.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
6. A bond that may be exchanged for common shares is
a) a bearer bond.
b) a convertible bond.
c) an income bond.
d) a registered bond.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
7. A bond that is linked to natural gas is an example of
a) a commodity-backed bond.
b) a revenue bond.
c) a deep discount bond.
d) a junk bond.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
8. The rate of interest actually earned by bondholders is called the
a) stated rate.
b) coupon rate.
c) dividend rate.
d) effective yield or market rate.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
9. Mars Corp. issued ten-year bonds with a maturity value of $400,000. If the bonds were issued at a premium, this indicates that
a) the market rate was higher than the stated rate.
b) the stated rate was higher than the market rate.
c) the market and stated rates were the same.
d) no relationship exists between the two rates.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
10 If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will be
a) higher than it would have been had the effective interest method of amortization been used.
b) less than it would have been had the effective interest method of amortization been used.
c) the same as it would have been had the effective interest method of amortization been used.
d) less than the stated rate of interest.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
11 Using the effective interest method of bond discount or premium amortization, the periodic interest expense is equal to the
a) stated rate multiplied by the face value of the bonds.
b) market rate multiplied by the beginning-of-period carrying value of the bonds.
c) stated rate multiplied by the beginning-of-period carrying value of the bonds.
d) market rate multiplied by the face value of the bonds.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
12. 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.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
13. If bonds are issued between interest dates, the entry on the books of the issuing corporation could include a
a) debit to Interest Payable.
b) credit to Interest Receivable.
c) credit to Interest Expense.
d) credit to Unearned Interest.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
14. When the interest payment dates of a bond are May 1 and November 1, and a bond issue is sold on June 1, the amount of cash received by the issuer will be
a) decreased by accrued interest from June 1 to November 1.
b) decreased by accrued interest from May 1 to June 1.
c) increased by accrued interest from June 1 to November 1.
d) increased by accrued interest from May 1 to June 1.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
15. How should a long-term bond initially be valued?
a) at the future value of the future cash flows
b) at the present value of the future cash flows
c) at the present value of the interest to be paid
d) at the maturity value of the bond
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
16. A bond’s face value is also called
a) the par value or the present value.
b) the principal amount or the present value.
c) the amortized value or the maturity value.
d) the par value or the maturity value.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
17. If a long-term note is issued with zero interest or for nonmonetary consideration,
a) the debtor must first try to value the non-monetary asset(s) involved in the transaction.
b) a reasonable interest rate must be imputed.
c) the debtor always tries to create a gain with such a transaction.
d) the note is a non-monetary liability.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
18. When valuing financial instruments at fair value (the fair value option),
a) ASPE allows this option only for certain financial instruments.
b) IFRS allows this for all financial instruments.
c) IFRS requires that this option be used only where fair value does not result in more relevant information.
d) IFRS requires that non-performance risk be included in the fair value measurement.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
19. When a note payable is issued for property, goods, or services, the present value of the note should preferably be measured by
a) the present value of the property, goods or services.
b) the fair value of the property, goods, or services.
c) the fair value of the debt instrument.
d) the present value of the debt instrument.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
20. On January 1, 2023, Cotton Corp. issued eight-year, 3% bonds with a face value of $600,000, with interest payable semi-annually on June 30 and December 31. The bonds were sold to yield 4%. Table values are:
Present value of 1 for 8 periods at 3% .789
Present value of 1 for 8 periods at 4% .731
Present value of 1 for 16 periods at 1.5% .788
Present value of 1 for 16 periods at 2% .728
Present value of annuity for 8 periods at 3% 7.020
Present value of annuity for 8 periods at 2% 7.325
Present value of annuity for 16 periods at 1.5% 14.131
Present value of annuity for 16 periods at 2% 13.578
The present value of the principal is
a) $436,800.
b) $438,600.
c) $472,800.
d) $473,400.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $600,000 ×.728 = $436,800
21. On January 1, 2023, Cotton Corp. issued eight-year, 3% bonds with a face value of $600,000, with interest payable semi-annually on June 30 and December 31. The bonds were sold to yield 4%. Table values are:
Present value of 1 for 8 periods at 3% .789
Present value of 1 for 8 periods at 4% .731
Present value of 1 for 16 periods at 1.5% .788
Present value of 1 for 16 periods at 2% .728
Present value of annuity for 8 periods at 3% 7.020
Present value of annuity for 8 periods at 2% 7.325
Present value of annuity for 16 periods at 1.5% 14.131
Present value of annuity for 16 periods at 2% 13.578
The present value of the interest is
a) $122,202.
b) $126,360.
c) $127,179.
d) $131,850.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($600,000 ×.015) × 13.578 = $122,202
22. On January 1, 2023, Cotton Corp. issued eight-year, 3% bonds with a face value of $600,000, with interest payable semi-annually on June 30 and December 31. The bonds were sold to yield 4%. Table values are:
Present value of 1 for 8 periods at 3% .789
Present value of 1 for 8 periods at 4% .731
Present value of 1 for 16 periods at 1.5% .788
Present value of 1 for 16 periods at 2% .728
Present value of annuity for 8 periods at 3% 7.020
Present value of annuity for 8 periods at 2% 7.325
Present value of annuity for 16 periods at 1.5% 14.131
Present value of annuity for 16 periods at 2% 13.578
The issue price of the bonds is
a) $559,002.
b) $599,760.
c) $570,450.
d) $599,979.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $600,000 ×.728 = $436,800; ($600,000 ×.015) × 13.578 = $122,202;
$436,800 + $122,202 = $559,002
23. On January 1, 2023, Neisha Ltd. sold five-year, 6% bonds with a face value of $400,000. Interest will be paid semi-annually on June 30 and December 31. The bonds were sold for $417,505 to yield 5%. Using the effective interest method of amortization of bond discount or premium, interest expense for 2023 is
a) $20,000.
b) $20,837.
c) $27,501.
d) $24,000.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Interest June 30: $417,505 x .025 = $10,438
Amortization of premium $12,000 – $10,438 = $1,562
CV is now $417,505 – $1,562 = $415,943
Interest Dec 31: $415,943 × .025 = $10,399
Total interest for 2023: $20,837
24. On January 2, 2023, McIntosh Ltd. sold five-year, 4% bonds with a face value of $500,000. Interest will be paid semi-annually on June 30 and December 31. The bonds were sold for $478,121 to yield 5%. Using the effective interest method of amortization of bond discount or premium, interest expense for 2023 is
a) $20,000.
b) $11,953.
c) $23,955.
d) $25,000.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Interest June 30: $478,121 ×.025= $11,953
Amortization of discount $11,953 – $10,000 = $1,953
CV is now $478,121 + $1,953 = $480,074
Interest Dec 31: $480,074 ×.025 = 12,002
Total interest for 2023: $23,955
25. On January 1, 2023, Susan Hong lent $60,104 to Ben Bachu. A zero-interest-bearing note (face amount, $80,000) was exchanged solely for cash; no other rights or privileges were exchanged. The note is to be repaid on December 31, 2025. The market rate of interest for a loan of this type is 10%. To the nearest dollar, and using the effective interest method, how much interest revenue should Ms. Hong recognize in 2023?
a) $6,010
b) $8,000
c) $18,030
d) $24,000
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $60,104 ×.10 = $6,010
26. On January 1, 2023, Alvin Corp. sold property to Marvin Ltd., for which Alvin had originally paid $570,000. There was no established exchange price for this property. Marvin gave Alvin a $900,000, zero-interest-bearing note, payable in three equal annual instalments of $300,000, with the first payment due December 31, 2023. The note also has no ready market. The market rate of interest for a note of this type is 10%. The present value of a $900,000 note payable in three equal annual instalments of $300,000 at 10% is $746,056. To the nearest dollar, and using the effective interest method, how much interest revenue should Alvin recognize in 2023?
a) $0
b) $30,000
c) $74,606
d) $90,000
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $746,056 ×.10 = $74,606
27. On January 1, 2023, Queen Ltd. sold property to King Company. There was no established exchange price for the property, and King gave Queen a $3,000,000, zero-interest-bearing note payable in five equal annual instalments of $600,000, with the first payment due December 31, 2023. The market rate of interest for a note of this type is 9%. The present value of the note at 9% was $2,333,791 at January 1, 2023. What should be the balance of the Note Payable to Queen Ltd. account on King’s December 31, 2023 adjusted trial balance, assuming that the note is recorded at net and the effective interest method is used?
a) $1,943,832
b) $2,333,791
c) $2,400,000
d) $3,000,000
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Interest portion of Dec. 31 payment = $2,333,791 x 9% = $210,041; therefore, principal reduction is $600,000 – $210,041 = $389,959, and carrying value of note is $2,333,791 – $389,959 = $1,943,832
28. On July 1, 2023, Markham Corp. issued $800,000, 4% bonds at 98 plus accrued interest. The bonds are dated April 1, 2023 and mature on April 1, 2030. Interest is payable semi-annually on April 1 and October 1. How much did Markham receive from the bond issuance?
a) $776,000
b) $784,000
c) $792,000
d) $800,000
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($800,000 ×.98) + ($800,000 × .04 × 3 ÷ 12) = $792,000
29. On January 1, 2023, Neeson Ltd. issued $2,000,000, 5% bonds, which mature on January 1, 2030. The bonds were issued for $2,120,045 to yield 4%. Neeson uses the effective interest method of amortizing bond premium. Interest is payable annually on December 31. At December 31, 2023, the adjusted balance in the Bonds Payable account should be
a) $2,120,045.
b) $2,104,847.
c) $2,135,243.
d) $2,000,000.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Amortization of premium $100,000 – ($2,120,045 ×.04) = $15,198;
CV is $2,120,045 – $15,198 = $2,104,847
30. On July 1, 2023, Pike Inc. issued $500,000, 9% bonds, which mature on July 1, 2030. The bonds were issued for $469,500 to yield 10%. Pike uses the effective interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, 2025, the adjusted balance in the Bonds Payable account should be
a) $500,000.
b) $493,900.
c) $473,595.
d) $471,450.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: 2023–2024: CV is $469,500 + [($469,500 ×.1) – $45,000] = $471,450;
2024–2025: CV is $471,450 + [($471,450 x.1) – $45,000] = $473,595
31. On January 1, 2023, Helium Corp. sold $500,000, 4% bonds for $477,102 to yield 6%. Interest is payable semi-annually on January 1 and July 1. Helium uses the effective interest method of amortizing bond discount. What amount should Helium report as interest expense for the six months ended June 30, 2023?
a) $10,000
b) $14,313
c) $20,000
d) $28,626
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $477,102 ×.03 = $14,313
32. A $700,000 bond is issued on January 1, 2023. Assuming the bond was issued at 95, the bondholder’s initial entry would include
a) a debit of $700,000 to Cash.
b) a debit of $665,000 to Cash.
c) a debit of $735,000 to Cash.
d) a debit of $745,000 to Cash.
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $700,000 x .95 = $665,000
33. A bond with a five-year maturity and interest paid on a semi-annual basis has a discount of $5,000 upon issuance. Under the straight-line method, semi-annual amortization would be
a) $1,000.
b) $500.
c) $250.
d) $5,000.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $5,000/10 = $5,000
34. Which of the following statements is correct?
a) IFRS requires the effective interest method to be used to amortize bond premiums and discounts; ASPE permits either the effective interest method or the straight-line method.
b) ASPE requires the effective interest method to be used to amortize bond premiums and discounts; IFRS permits either the effective interest method or the straight-line method.
c) Both IFRS and ASPE require the effective interest method to be used to amortize bond premiums and discounts.
d) Both IFRS and ASPE permit either the effective interest method or the straight-line method to be used to amortize bond premiums and discounts.
Difficulty: Easy
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Identify major differences in accounting standards between IFRS and ASPE, and what changes are expected in the near future.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
35. A ten-year bond was issued in 2023 at a discount with a call provision to retire the bonds. When the bond issuer exercised the call provision on an interest date in 2025, the carrying value of the bond was less than the call price. The amount of bond liability removed from the accounts in 2025 would be the
a) call price.
b) maturity value.
c) carrying value.
d) face amount plus unamortized discount.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
36. Under ASPE, if a debt refunding is viewed as a modification or renegotiation, then
a) a new effective interest rate is calculated.
b) a gain or loss is recorded.
c) there is no change in the accounting for the debt.
d) the old debt is derecognized.
Difficulty: Easy
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
37. Under ASPE, in a troubled debt restructuring in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows,
a) an extraordinary gain should be recognized by the debtor.
b) a gain should be recognized by the debtor.
c) a new effective-interest rate must be calculated.
d) no interest expense or revenue should be recognized in the future.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
38. A troubled debt restructuring, under IFRS, will generally result in a
a) loss by the debtor and a gain by the creditor.
b) loss by both the debtor and the creditor.
c) gain by both the debtor and the creditor.
d) gain by the debtor and a loss by the creditor.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
39. In a troubled debt restructuring, under IFRS, in which the debt is settled by a transfer of assets with a fair market value less the carrying amount of the debt, the debtor would
a) not recognize a gain or loss on the settlement.
b) recognize a gain on the settlement.
c) recognize a loss on the settlement.
d) only record a memo in the general ledger.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
40. In a troubled debt restructuring, under IFRS. in which the debt is continued with modified terms and the carrying amount of the debt is less than the total future cash flows, the creditor should
a) calculate a new effective-interest rate.
b) not recognize a loss.
c) calculate its loss using the historical effective interest rate of the loan.
d) calculate its loss using the current effective interest rate of the loan.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
41. When the debtor sets aside money in a trust such that the investment and any return will be sufficient to pay the principal and the interest to the creditor, but the creditor does NOT release the company from the primary obligation to settle the debt, the arrangement is known as
a) in-substance defeasance.
b) in-substance refunding.
c) substantive repayment.
d) legal defeasance.
Difficulty: Easy
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
42. Which of the following arrangements would NOT represent a possible example of “off-balance-sheet financing”?
a) non-consolidated entities
b) variable interest entities
c) operating leases
d) capital or financing leases
Difficulty: Easy
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
43. The December 31, 2023, statement of financial position of Cotton Corporation includes the following:
9% bonds payable due December 31, 2029 $718,000
The bonds have a face value of $700,000, and were issued on December 31, 2022, at 103, with interest payable on July 1 and December 31 of each year. Cotton uses straight-line amortization to amortize bond premium or discount. On March 1, 2024, Cotton retired $280,000 of these bonds at 98 plus accrued interest. Ignoring income taxes, what should Cotton record as a gain on retirement of these bonds?
a) $7,560
b) $12,600
c) $12,800
d) $14,000
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ×.4 = $287,000 (CV of retired bonds);
$287,000 – ($280,000 ×.98) = $12,600
44. On January 1, 2023, Linen Corp. issued $450,000 (face value), 10%, ten-year bonds at 103. The bonds are callable at 105. Linen has recorded amortization of the bond premium by the straight-line method. On December 31, 2029, Linen repurchased $100,000 of the bonds in the open market at 96. Bond interest expense and premium amortization have been recorded for 2029. Ignoring income taxes, what is the loss or gain arising from this reacquisition?
a) a gain of $4,900
b) a loss of $4,900
c) a gain of $6,100
d) a loss of $6,100
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: [($450,000 x 1.03) – ($13,500 × 7/10)] x $100,000/$450,000 = $100,900 (CV of retired bonds);
$100,900 – ($100,000 ×.96) = $4,900 gain
45. At December 31, 2023, the 10% bonds payable of Paisley Inc. had a carrying value of $760,000. The bonds, which had a face value of $800,000, were issued at a discount to yield 12%. The amortization of the bond discount had been recorded using the effective interest method. Interest was being paid on January 1 and July 1 of each year. The July 1, 2024, interest payment and discount amortization had been correctly recorded. On July 2, 2024, Paisley retired the bonds at 102. Ignoring income taxes, what is the loss that should be recorded on the early retirement of the bonds?
a) $16,000
b) $44,800
c) $50,400
d) $56,000
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($760,000 × 1.06) – ($800,000 ×.05) = $765,600 (CV of bonds);
$765,600 – ($800,000 × 1.02) = $50,400
46. Hills Corp. called an outstanding bond obligation four years before maturity. At that time there was an unamortized discount of $200,000. To extinguish this debt, Hills had to pay a call premium of $40,000. Ignoring income tax considerations, how should these amounts be treated for accounting purposes?
a) Amortize $240,000 over four years.
b) Record a $240,000 loss in the year of extinguishment.
c) Record a $40,000 loss in the year of extinguishment and amortize $200,000 over four years.
d) Either amortize $240,000 over four years or record a $240,000 loss immediately, whichever management selects.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $200,000 + $40,000 = $240,000 loss
47. At December 31, 2023, the 12% bonds payable of Leather Corp. had a carrying value of $312,000. The bonds, which had a face value of $300,000, were issued at a premium to yield 10%. Leather uses the effective interest method of amortization of bond premium. Interest is paid on June 30 and December 31. On June 30, 2024, Leather retired the bonds at 104 plus accrued interest. The loss on retirement, ignoring taxes, is
a) $0.
b) $2,400.
c) $3,720.
d) $12,000.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($312,000 – [($300,000 x.06) – ($312,000 ×.05)] = $309,600 (CV of bonds);
($300,000 × 1.04) – $309,600 = $2,400
48. On December 31, 2023, Diaz Corp. is in financial difficulty and cannot pay a $900,000 note with $90,000 accrued interest payable to Cameron Ltd., which is now due. Cameron agrees to accept from Diaz equipment that has a fair value of $435,000, an original cost of $720,000, and accumulated depreciation of $345,000. Cameron also forgives the accrued interest, extends the maturity date to December 31, 2025, reduces the face amount of the note to $375,000, and reduces the market interest rate to 6%, with interest payable at the end of each year. Diaz should recognize a gain or loss on the transfer of the equipment of
a) $0.
b) $60,000 gain.
c) $90,000 gain.
d) $285,000 loss.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $435,000 – ($720,000 – $345,000) = $60,000
49. On December 31, 2023, Diaz Corp. is in financial difficulty and cannot pay a $900,000 note with $90,000 accrued interest payable to Cameron Ltd., which is now due. Cameron agrees to accept from Diaz equipment that has a fair value of $435,000, an original cost of $720,000, and accumulated depreciation of $345,000. Cameron also forgives the accrued interest, extends the maturity date to December 31, 2025, reduces the face amount of the note to $375,000, and reduces the market interest rate to 6%, with interest payable at the end of each year. Diaz should recognize a gain on the partial settlement and restructure of the debt of
a) $0.
b) $22,500.
c) $112,500.
d) $180,000.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($900,000 + $90,000) – ($435,000 + $375,000) = $180,000;
PV of future cash flows for new debt calculated as: (FV = $375,000; PMT = $22,500; N= 2 and I = 10%) $348,967 is more than 10% different from the PV of existing debt.
($990,000 – $435,000) = $555,000
50. On December 31, 2023, Diaz Corp. is in financial difficulty and cannot pay a $900,000 note with $90,000 accrued interest payable to Cameron Ltd., which is now due. Cameron agrees to accept from Diaz equipment that has a fair value of $435,000, an original cost of $720,000, and accumulated depreciation of $345,000. Cameron also forgives the accrued interest, extends the maturity date to December 31, 2025, reduces the face amount of the note to $375,000, and reduces the market interest rate to 6%, with interest payable at the end of each year. Diaz should record interest expense for 2024 of
a) $0.
b) $22,500.
c) $45,000.
d) $67,500.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $375,000 ×.06 = $22,500
51. On January 1, 2023, Siamese Inc. redeemed its 15-year, $600,000 par value bonds at 103. They were originally issued on January 1, 2011 at 98 with a maturity date of January 1, 2026. Siamese amortizes bond discounts and premiums using the straight-line method. Ignoring income taxes, what amount of loss should Siamese recognize on the redemption of these bonds?
a) $18,000
b) $20,400
c) $9,600
d) $39,600
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($600,000 × 1.03) – [$588,000 + ($12,000 x 12 ÷ 15)] = $20,400
52. On its December 31, 2023 statement of financial position, Mackeral Ltd. reported bonds payable of $500,000. The bonds had been issued at par. On January 2, 2024, Mackeral retired one half of the outstanding bonds at 101 plus a call premium of $20,000. Ignoring income taxes, what amount should Mackeral report on its 2024 income statement as loss on extinguishment of debt?
a) $22,500
b) $20,000
c) $2,500
d) $0
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: [($250,000 x 1.01) + $20,000)] – [$500,000 × ½] = $22,500
53. On January 1, 2023, Halibut Corp. issued $1,000,000, 10% bonds for $1,040,000. These bonds were to mature on January 1, 2033 but were callable at 101 any time after December 31, 2023. Interest was payable semi-annually on July 1 and January 1. On July 1, 2028, Halibut called all the bonds and retired them. Bond premium was amortized on a straight-line basis. Ignoring income taxes, Halibut's gain or loss in 2028 on this early extinguishment of debt was
a) $8,000 loss.
b) $8,000 gain.
c) $10,000 loss.
d) $12,000 gain.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: [$1,040,000 – ($40,000 x 11/20)] – ($1,000,000 × 1.01) = $8,000 gain
54. On July 1, 2023, Tilapia Corp. had outstanding 8%, $1,000,000, 10-year bonds maturing on June 30, 2030. Interest is payable semi-annually on June 30 and December 31. Assume all appropriate entries had been prepared and posted at June 30, 2024. The carrying value of the bond at June 30, 2024 was $965,000. At this time, Tilapia purchased all the bonds at 94 and retired them. What is the gain or loss on this early extinguishment of debt?
a) $60,000 gain
b) $35,000 loss
c) $25,000 gain
d) $25,000 loss
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $965,000 – ($1,000,000 x.94) = $25,000 gain
55. Pineapple owes Dole a $600,000, 12%, three-year note dated December 31, 2021. Pineapple has been experiencing financial difficulties, and still owes accrued interest of $72,000 on this note at December 31, 2023. Under a troubled debt restructuring, on December 31, 2023, Dole agrees to settle the note plus the accrued interest for land that Pineapple owns, which has a fair value of $540,000. Pineapple's original cost of the land is $435,000. Ignoring income taxes, on its 2023 income statement, what should Pineapple report as a result of the troubled debt restructuring?
Gain on Gain on
Disposition of Land Restructuring of Debt
a) $237,000 $0
b) $165,000 $0
c) $105,000 $60,000
d) $105,000 $132,000
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: $540,000 – $435,000 = $105,000;
($600,000 + $72,000) – $540,000 = $132,000
56. In-substance defeasance is a term used to refer to an arrangement whereby
a) the creditor of the original debt agrees to look to another company/trust for repayment and give up its claim on the company.
b) a government unit agrees to make payments on behalf of the company to the creditor.
c) a company legally settles its liability through the issuance of another bond.
d) a company provides for the future payments of a long-term liability by placing purchased securities in an irrevocable trust.
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
57. Which of the following is NOT a form of off-balance-sheet financing?
a) non-consolidated entities
b) special purpose entities
c) consolidated entities
d) operating leases
Difficulty: Easy
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
58. How should long-term debt be reported if it matures within one year and the company has arranged, before its current year end, to convert the debt into shares?
a) as non-current and accompanied with a note explaining the method to be used in its liquidation
b) in a special section between liabilities and shareholders' equity
c) as non-current
d) as a current liability
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
59. Complex financial instruments make the distinction between debt and equity
a) easier to define.
b) harder to define.
c) less important.
d) irrelevant.
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
60. Note disclosures for long-term debt generally include all of the following, EXCEPT
a) assets pledged as security.
b) names of specific creditors.
c) restrictions imposed by creditors.
d) call provisions and conversion privileges.
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
61. Which of the following is a required disclosure with respect to liabilities?
a) who the creditors are and how much is owed to each
b) payment terms for trade accounts payable
c) future payments and maturity amounts for each of the next ten years
d) details of assets pledged as collateral
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
62. Which of the following is NOT a required disclosure with respect to liabilities?
a) maturity dates and interest rates for each outstanding bond issue
b) payment terms for trade accounts payable
c) future payments and maturity amounts for each of the next five years
d) details of assets pledged as collateral
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
63. The times interest earned ratio is calculated by dividing
a) net income by interest expense.
b) income before taxes by interest expense.
c) income before income taxes plus interest expense by interest expense.
d) net income plus interest expense by interest expense.
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
64. The debt to total assets ratio is calculated by dividing
a) total liabilities by total assets.
b) long-term liabilities by total assets.
c) current liabilities by total assets.
d) total assets by total liabilities.
Difficulty: Easy
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
65. The times interest earned ratio measures
a) the amount of interest expense related to long-term debt.
b) the percentage of total assets financed by creditors.
c) the profitability of an enterprise.
d) an enterprise’s ability to meet interest payments as they come due.
Difficulty: Medium
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
66. The debt to total assets ratio measures
a) the amount of debt related to interest expense.
b) the percentage of total assets financed by creditors.
c) the likelihood an enterprise will default on its obligations.
d) the profitability of an enterprise.
Difficulty: Medium
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Analytic
67. Continental Company’s 2023 financial statements contain the following selected data:
Income tax expense $80,000
Interest expense 20,000
Net income 160,000
Continental’s times interest earned for 2023 is
a) 8 times.
b) 11 times.
c) 12 times.
d) 13 times.
Difficulty: Medium
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($160,000 + $80,000 + $20,000) ÷ $20,000 = 13 times
68. Granger Ltd. reported the following information on its most recent statement of financial position:
Current assets $200,000
Total assets 797,000
Current liabilities 160,000
Total equity 350,000
To the nearest percent, what is Granger’s debt to total assets?
a) 20%
b) 44%
c) 56%
d) 80%
Difficulty: Medium
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Total liabilities = $797,000 – $350,000 = $447,000;
Debt to total assets = $447,000 ÷ $797,000 = 56%
69. Carly Corporation’s 2023 financial statements contain the following select data:
Income before tax $160,000
Income tax expense 80,000
Interest expense 20,000
Carly’s times interest earned for 2023 is
a) 8 times.
b) 9 times.
c) 12 times.
d) 13 times.
Difficulty: Medium
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: ($160,000 + $20,000) ÷ $20,000 = 9 times
70. HUB Ltd. reported the following information on its most recent statement of financial position:
Current assets $200,000
Non-current assets 597,000
Total equity 350,000
What percentage of the company is capitalized by equity?
a) 20%
b) 44%
c) 56%
d) 80%
Difficulty: Medium
Learning Objective: Explain how long-term debt is presented, disclosed, and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Feedback: Total assets: $200,000 + $597,000 = $797,000;
Capitalized by equity = $350,000 ÷ $797,000 = 44%.
71. Which of the following statements is true?
a) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the date of the financial statements, according to ASPE; and before the date of the issue of the SFP, according to IFRS.
b) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the date of the SFP, according to IFRS; and before the date of the issue of the financial statements, according to ASPE.
c) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the date of the financial statements, according to IFRS and ASPE.
d) Refinanced long-term debt may be reported as long-term rather than current if the refinancing has been completed before the issue of the financial statements, according to IFRS and ASPE.
Difficulty: Easy
Learning Objective: Identify major differences in accounting standards between IFRS and ASPE, and what changes are expected in the near future.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
72. When restructuring has taken place with no substantial modification,
a) the interest rate is adjusted under ASPE only.
b) the interest rate is adjusted under IFRS only.
c) gains/losses are recognized under ASPE only.
d) gains/losses are not recognized under IFRS or ASPE.
Difficulty: Easy
Learning Objective: Identify major differences in accounting standards between IFRS and ASPE, and what changes are expected in the near future.
Section Reference: IFRS/ASPE Comparison
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
EXERCISES
Ex. 14-73 Underwriting for bond issues
Explain the difference between firm underwriting and best efforts underwriting.
Solution 14-73
With firm underwriting, an investment bank or brokerage will underwrite a bond issue by guaranteeing a specified amount to the bond issuer. Thus, the broker assumes the risk of selling the bonds for whatever they can get.
On the other hand, with best efforts underwriting, the agent (broker) will sell the bond issue for a commission that will be deducted from the sale proceeds.
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 14-74 Terms related to long-term debt
Place the letter of the best matching phrase before each term.
1. Debenture 6. Debt to total assets ratio
2. Bearer bonds 7. Term bonds
3. Income bonds 8. Leverage
4. Carrying value 9. Callable bonds
5. Stated rate 10. Market rate
a) Bonds that mature on a single date.
b) Rate set by party issuing the bonds which appears on the bond indenture.
c) Bonds that pay no interest unless the issuer is profitable.
d) Rate of interest actually earned by the bondholders.
e) Results when bonds are sold below par.
f) The practice of using other peoples’ money to maximize returns to shareholders.
g) Bonds not recorded in the holder’s name; can be easily transferred from one party to another.
h) Give the issuer the right to call in and retire bonds before maturity.
i) Maturity value of bonds less any discount or plus any premium at any given date.
j) Ratio of current assets to current liabilities.
k) Unsecured debt instruments not backed by collateral.
l) Measures the percentage of total assets provided by creditors.
m) Indicates the company’s ability to meet interest payments as they come due.
Solution 14-74
1. k
2. g
3. c
4. i
5. b
6. l
7. a
8. f
9. h
10. d
Difficulty: Easy
Learning Objective: Understand the nature of long-term debt financing arrangements.
Section Reference: Understanding Debt Instruments
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Explain how long-term debt is presented, disclosed and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
Ex. 14-75 Amortization of premium
On May 1, 2023, Providex Industries Ltd. issued $2,000,000, 10% bonds and received cash proceeds of $2,243,313. The bonds pay interest semi-annually on May 1 and November 1. The maturity date on these bonds is November 1, 2031. Providex uses the effective-interest method of amortizing bond discounts and premiums. The bonds were sold to yield an effective-interest rate of 8%.
Instructions
a) Calculate the total dollar amount of discount or premium amortization during the first year that these bonds were outstanding. Show calculations and round values to the nearest dollar.
b) CRITICAL THINKING: The CEO of Providex is does not understand why the interest expense that has been recognized is different from the amount of cash that has been paid. Explain to the CEO why this has occurred.
Solution 14-75
a) Interest Cash Premium Carrying
Date Expense Paid Amortization Value of Bonds
May 1/23 $2,243,313
Nov 1/23 $89,733 $100,000 $10,268 2,233,045
May 1/24 89,322 100,000 10,678 2,222,367
Total $20,946
b) CRITICAL THINKING: While the bond is outstanding, its price is affected by several variables, but especially by the market rate of interest. There is an inverse relationship between the market interest rate and the bond price. That is, when interest rates increase, the bond’s price decreases, and vice versa. The cash paid is based on the stated interest rate, while the interest expense recognized is based on the effective interest rate.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-76 Bond issue price and premium amortization
On January 1, 2023, Blindo Corp. issued ten-year, 12% bonds with a face value of $500,000, with interest payable semi-annually on June 30 and December 31. At the time, the market rate was 10%.
Instructions
a) Use your calculator to calculate the issue price of the bonds. Round the answer to the nearest dollar.
b) Independent of your solution to part a), assume that the issue price was $562,000. Prepare the amortization table for 2023 using the effective interest rate method. Round values to the nearest dollar.
Solution 14-76
a) N 20 %i 5 FV 500,000 PMT 30000 CPT PV => $562,311
b) Cash Interest Premium Carrying
Date Paid Expense Amortized Value of Bonds
Jan 1/23 $562,000
Jun 30/23 $30,000 $28,100 $1,900 560,100
Dec 31/23 30,000 28,005 1,995 558,105
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-77 Amortization of discount
On May 1, 2023, Salinas Industries Ltd. issued $2,000,000, 8% bonds and received cash proceeds of $1,774,519. The bonds pay interest semi-annually on May 1 and November 1. The maturity date on these bonds is November 1, 2031. Salinas uses the effective-interest method of amortizing bond discounts and premiums. The bonds were sold to yield an effective-interest rate of 10%.
Instructions
Calculate the total dollar amount of discount or premium amortization during the first year that these bonds were outstanding. Show calculations and round values to the nearest dollar.
Solution 14-77
Interest Cash Discount Carrying
Date Expense Paid Amortization Value of Bonds
May 1/23 $1,774,519
Nov 1/23 $88,726 $80,000 $8,726 1,783,245
May 1/24 89,162 80,000 9,162 1,792,407
Total $17,888
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-78 Bond issue price and discount amortization
On January 1, 2023, Oxnard Corp. issued ten-year, 10% bonds with a face value of $500,000, with interest payable semi-annually on June 30 and December 31. At the time, the market rate was 12%.
Instructions
a) Use your calculator to calculate the issue price of the bonds. Round the answer to the nearest dollar.
b) Independent of your solution to part a), assume that the issue price was $442,000. Prepare the amortization table for 2023. Round values to the nearest dollar.
c) CRITICAL THINKING: Why would an investor agree to purchase a bond at a discount? How is the investor’s rate of return affected?
Solution 14-78
a) N 20 %i 6 FV 500,000 PMT 25000 CPT PV => $442,650
b) Cash Interest Discount Carrying
Date Paid Expense Amortized Value of Bonds
Jan 1/23 $442,000
Jun 30/23 $25,000 $26,520 $1,520 443,520
Dec 31/23 25,000 26,611 1,611 445,131
c) CRITICAL THINKING: When a bond sells below its face value, it means that investors are demanding a rate of interest that is higher than the stated rate. The investors are not satisfied with the stated rate because they can earn a greater rate on alternative investments of equal risk.
Given that an investor cannot change the stated rate of the bond, they will refuse to pay face value for the bonds and instead achieve the effective rate of interest that they require by lowering the amount invested in the bonds (of the purchases price). The result is that the investors receive interest payments at the stated rate calculated on the face value, but they are essentially earning an effective rate that is higher than the stated rate because they paid less than face value for the bonds.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-79 Note issued for cash and other rights
Rebecca Land Corp. issued a 5-year, zero-interest-bearing note with a $1,000,000 face value to Lindsay Inc. for $1,000,000 cash. Rebecca also gave Lindsay the right to use a parcel of land for equipment storage for 5 years. Interest rates for notes of this type were 8% at issue.
Instructions
Prepare the journal entries to record the issuance of the note by (a) Rebecca and (b) Lindsay.
Use your calculator and round values to the nearest dollar.
Solution 14-79
a) Rebecca
Cash 1,000,000
Notes Payable *680,583
Unearned Revenue (Rent) 319,417
b) Lindsay
Notes Receivable *680,583
Prepaid Rent 319,417
Cash 1,000,000
* N 5 %i 8 1000000 FV CPT PV => 680,583
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-80 Note issued for non-cash consideration
On July 1, 2023, Modesto Holdings Ltd. issued a $50,000 face value note due June 30, 2026 with a stated interest rate of 4% to Modern Consultants in return for consulting services provided in 2023. The value of the consulting services is not readily determinable, and the note is not readily marketable. Based on a credit analysis, a reasonable imputed interest rate would be 12%.
Instructions
Prepare the journal entry to record the issuance of the note by Modesto. Use your calculator and round values to the nearest dollar.
Solution 14-80
Operating (consulting) Expense 40,393
Notes Payable 40,393
N 3 %i 12 FV 50000 PMT 2000 (50,000 x 4%) CPT PV => 40,393
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-81 Sale and subsequent buyback of bonds
On July 1, 2023, Davis Corp. issued $800,000 par value, 10%, 10-year bonds, with interest payable semi-annually on January 1 and July 1. The bonds were issued for $908,722. On January 2, 2025, Davis offered to buy back the bonds at 103. Forty percent of the bondholders accepted the offer. Davis uses the effective-interest method of amortizing premium or discount.
Instructions
a) Prepare the journal entry to record the bond issuance.
b) Prepare the adjusting entry at December 31, 2023, the end of the fiscal year.
c) Prepare the entry for the interest payment on January 1, 2024.
d) Prepare the entry to record the retirement of the bonds on January 2, 2025.
Round all values to the nearest dollar.
Solution 14-81
First you need to solve for the yield, which is 8%.
PV 908722 N 20 PMT (40000) FV (800000) CPT %i => 8%
Date | Interest Payment | Interest Expense | Premium Amortization | Carrying Value |
Jul 1/23 | 908,722 | |||
Jan 1/24 | 40,000 | 36,349 | 3,651 | 905,071 |
Jul 1/25 | 40,000 | 36,203 | 3,797 | 901,274 |
Jan 1/27 | 40,000 | 36,051 | 3,949 | 897,325 |
a) Cash…………………………………………………… 908,722
Bonds Payable 908,722
b) Interest Expense 36,349
Bonds Payable 3,651
Interest Payable 40,000
(Interest expense: $908,722 × 8% × ½ = $36,349)
c) Interest Payable 40,000
Cash 40,000
d) Bonds Payable (897,325 x 40%)……. 358,930
Cash 329,600
Gain on Redemption of Bonds 29,330
Bond retirement price = 800,000 x 1.03 x 40% = 329,600
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-82 Entries for bonds payable
Prepare journal entries to record the following transactions related to Chico Ltd.’s long-term bonds:
a) On April 1, 2023, Chico issued $600,000, 9% bonds (dated January 1, 2023) for $645,442 including accrued interest. Interest is payable annually on January 1, and the bonds mature on January 1, 2033.
b) On July 1, 2025, Chico retired 30% of the bonds at 102 plus accrued interest. Chico uses straight-line amortization.
Solution 14-82
a) Cash 645,442
Bonds Payable 631,942
Interest Expense ($600,000 × 9% × 3 ÷ 12) 13,500
b) Interest Expense 7,609
Bonds Payable ($31,942 × 30% × 6 ÷ 117) 491
Cash ($600,000 x 30% × 9% × 6 ÷ 12) 8,100
Bonds Payable *187,371
Cash ($600,000 x 30% x 1.02) 183,600
Gain on Redemption of Bonds 3,771
*$180,000 plus unamortized Premium of ($31,942 x 30% x 90 ÷ 117 = $7,371) = $187,371
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-83 Repayment of bond before maturity
On January 1, 2023, Braveheart Corp. issued bonds with a par value of $1,000,000 at 98 (which is net of issue costs), due in 15 years. Six years after the issue date, the entire issue is called at 102 and cancelled.
Instructions
Prepare the journal entry to reflect the reacquisition of the bond assuming the straight-line amortization method.
Solution 14-83
Reacquisition price ($1,000,000 × 1.02) | $1,020,000 | |
Net carrying amount of bonds redeemed: | ||
Face value | $1,000,000 | |
Unamortized discount ($20,000a × 9/15) | ||
(amortized using straight-line basis) | _(12,000) | _ 988,000 |
Loss on redemption | $ 32,000 | |
a[$1,000,000 × (1 − 0.98)] | ||
Bonds Payable | 988,000 | |
Loss on Redemption of Bonds | 32,000 | |
Cash | 1,020,000 |
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-84 Retirement of bonds
On December 31, 2022, LaBrea Corp.’s statement of financial position included the following:
7.5% bonds payable, due December 31, 2030 $576,000
The bonds have a face value of $600,000, and were issued on December 31, 2020 at 95. Interest is payable semi-annually on June 30 and December 31. LaBrea uses straight-line amortization.
On April 1, 2023, LaBrea retired 20% of these bonds at 101 plus accrued interest.
Instructions
Prepare journal entries to record the retirement. Show calculations and round values to the nearest dollar.
Solution 14-84
Interest Expense 2,400
Cash ($600,000 × 20% x 7.5% × 3 ÷ 12) 2,250
Bonds Payable ($30,000 × 20% × 3 ÷ 120) 150
Bonds Payable *115,350
Loss on Redemption of Bonds 5,850
Cash 121,200
*$120,000 less unamortized discount of ($30,000 x 20% x 93 ÷ 120 = $4,650) = $115,350
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-85 Early extinguishment of debt and bond redemptions
On August 1, 2021, Fresno Inc. sold 8%, five-year bonds with a maturity value of $2,000,000 for $1,964,000. Interest on the bonds is payable semi-annually on August 1 and February 1. The bonds are callable at 104 at any time after August 1, 2023. By October 1, 2023, the market rate of interest has declined, and the market price of Fresno's bonds has increased to 102. The company decides to refund the bonds by selling a new 6% bond issue to mature in five years. Fresno begins to reacquire its 8% bonds in the market and is able to purchase $600,000 worth at 102. The remainder of the outstanding bonds are acquired by exercising the bond call feature.
Instructions
a) Calculate Fresno’s total gain or loss in reacquiring the 8% bonds. Assume the company uses straight-line amortization. Show calculations.
b) CRITICAL THINKING: Frezno’s CFO is reviewing your calculations for the bond redemption and has a few questions regarding your methodology. Explain the accounting procedures for the early redemption of bonds.
Solution 14-85
a) Reacquisition price:
$600,000 × 1.02 = $ 612,000
$1,400,000 × 1.04 = 1,456,000 $2,068,000
Less carrying value:
Face value 2,000,000
Unamortized discount
($36,000 × 34 ÷ 60) = 20,400 1,979,600
Loss on redemption $ 88,400
b) CRITICAL THINKING: At the time of redemption, any unamortized premium or discount must be amortized up to the reacquisition date. The amount paid on early redemption, including any call premium and expense of reacquisition, is the reacquisition price. Any excess of the carrying value over the reacquisition price is a gain from redemption, while any excess of the reacquisition price over the carrying value is a loss from redemption.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-86 Accounting for a troubled debt settlement
At December 31, 2023, Oscar Ltd. owes Wilde Corp. for a $300,000 note payable, plus accrued interest of $27,000. Oscar is now in financial difficulty and cannot repay Wilde. To settle the debt, Wilde agrees to accept from Oscar equipment with a fair value of $285,000, an original cost of $420,000, and accumulated depreciation to date of $98,000.
Instructions
a) Calculate the gain or loss to Oscar on the settlement of the debt.
b) Calculate the gain or loss to Oscar on the transfer of the equipment.
c) Prepare the journal entry on Oscar's books to record the settlement of the debt.
d) Prepare the journal entry on Wilde's books to record the settlement of the receivable.
Solution 14-86
a) Note payable $300,000
Interest payable 27,000
Carrying value of debt 327,000
Fair value of equipment 285,000
Gain on settlement of debt $ 42,000
b) Cost $420,000
Accumulated depreciation 98,000
Book value 322,000
Fair value of equipment 285,000
Loss on disposal of equipment $ 37,000
c) Notes Payable 300,000
Interest Payable 27,000
Accumulated Depreciation 98,000
Loss on Disposal of Equipment 37,000
Equipment 420,000
Gain on Settlement of Debt 42,000
d) Equipment 285,000
Loss on Settlement of Debt 42,000
Notes Receivable 300,000
Interest Receivable 27,000
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Ex. 14-87 Accounting for a troubled debt restructuring
On December 31, 2023, Riverside Inc. is in financial difficulty and cannot pay a $350,000 note (with $35,000 accrued interest payable) to Stockton Corp. Stockton agrees to forgive the accrued interest, extend the maturity date to December 31, 2025, and reduce the interest rate to 4%. The present value of the restructured cash flows is $299,500.
Instructions
Prepare entries for the following:
a) the restructure on Riverside's books.
b) the payment of interest on December 31, 2024.
c) the restructure on Stockton’s books.
Solution 14-87
a) Old debt: PV = $350,000 + $35,000 = $385,000
New debt: PV (given) = $299,500
The new debt differs by more than 10%: $85,500 ÷ $385,000 = 22.2%
Notes Payable (old) 350,000
Interest Payable 35,000
Notes Payable (new) 299,500
Gain on Restructuring of Debt 85,500
b) Imputed interest rate FV (350000) PV 299500 PMT (14000) ($350,000 x 4%) N 2
CPT %i => 12.61%
Interest Expense ($299,500 × 12.61%) 37,767
Cash 14,000
Notes Payable 23,767
c) Loss on Restructuring of Debt 85,500
Notes Receivable 50,500
Interest Receivable 35,000
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Analysis
AACSB: Analytic
Ex. 14-88 Accounting for troubled debt
a) What are the general rules for measuring and recognizing gain or loss by the debtor on a settlement of troubled debt, which includes the transfer of non-cash assets?
b) What are the general rules for measuring and recognizing a gain and for recording future payments by the debtor in a troubled debt restructuring?
Solution 14-88
a) If the settlement of debt includes the transfer of non-cash assets, a gain or loss is measured by the debtor as the difference between the fair value of the assets transferred and the carrying amount of the debt, including accrued interest. The debtor also recognizes a gain or loss on the disposal of assets as the difference between the fair value of the assets transferred and their book value.
b) If the carrying amount of the payable is greater than the discounted total future cash flows, based on currently prevailing interest rates, the gain is measured as the difference between the carrying amount and the discounted future cash flows. The gain is separately classified in the income statement and the nature of the restructuring is disclosed if the amount of the gain is material. The same treatment is given if a loss results. Future payments are used to reduce the principal and record interest expense.
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic
PROBLEMS
Pr. 14-89 Bond interest and premium amortization
On June 1, 20230, Yosemite Corp. sold 10-year, $500,000 (face value) bonds for $567,101. The bonds have a stated interest rate of 10% and a yield of 8% and pay interest annually on May 31 of each year. The bonds are to be accounted for using the effective-interest method.
Instructions
a) Construct a bond amortization table for this bond to indicate the amount of interest expense and premium amortization at each May 31. Include only the first four years. Make sure all columns and rows are properly labelled, and round to the nearest dollar.
b) The sales price of $567,101 was determined from present value tables. Explain how one would determine the price using present value tables, or by using a calculator.
c) Assuming that interest and premium amortization are recorded each May 31, prepare the adjusting entry at December 31, 2025 (fiscal year end). Round values to the nearest dollar.
Solution 14-89
a) Premium Carrying
Date Cash Paid Interest Expense Amortization Amount of Bonds
Jun 1/23 $567,101
May 31/24 $50,000 $45,368 $4,632 562,469
May 31/25 50,000 44,997 5,002 557,467
May 31/26 50,000 44,597 5,403 552,064
May 31/27 50,000 44,165 5,835 546,229
b) (1) Find the present value of $500,000 due in 10 years at 8%.
(2) Find the present value of 10 annual payments of $50,000 at 8%.
(3) Add (1) and (2) to obtain the present value of the principal and the interest payments.
Calculator: N 10 %i 8 PMT 50000 FV 500000 CPT PV
c) Interest Expense *26,015
Bonds Payable 3,152
Interest Payable **29,167
*7 ÷ 12 × $44,597 (from Table) = $26,015
**7 ÷ 12 × 10% × $500,000 = $29,167
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-90 Bond interest and premium amortization
On October 1, 2023, Whitfield Corp. issued $400,000 10% bonds, due on October 1, 2028. Interest is to be paid semi-annually on April 1 and October 1. The bonds were sold to yield 8% effective annual interest. Whitfield has a calendar year end.
Instructions
a) Complete the following amortization schedule for the dates indicated. Round all answers to the nearest dollar. Use the effective interest method.
Premium Carrying
Cash Paid Interest Expense Amortization Amount of Bonds
Oct 1/23 $432,444
Apr 1/24
Oct 1/24
b) Prepare the adjusting entry required for these bonds at December 31, 2024.
c) Calculate the interest expense to be reported in the income statement for the year ended December 31, 2024.
Solution 14-90
a)
Premium Carrying
Cash Paid Interest Expense Amortization Amount of Bonds
Oct 1/23 $432,444
Apr 1/24 $20,000 $17,298 $2,702 429,742
Oct 1/24 20,000 17,190 2,810 426,932
b) Interest Expense ($426,932 × 8% × 3 ÷ 12) 8,539
Bonds Payable ($10,000 – $8,539) 1,461
Interest Payable (1/2 × $20,000) 10,000
c) $ 8,649 (1/2 of $17,298)
17,190
8,539
$34,378
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-91 Bond interest and discount amortization
On June 1, 2023, Santa Ana Corp. sold 10-year, $500,000 (face value) bonds for $438,554. The bonds have a stated interest rate of 8% and a yield of 10% and pay interest annually on May 31 of each year. The bonds are to be accounted for using the effective-interest method.
Instructions
a) Construct a bond amortization table for this bond to indicate the amount of interest expense and discount amortization at each May 31. Include only the first four years. Make sure all columns and rows are properly labelled, and round to the nearest dollar.
b) The sales price of $438,554 was determined from present value tables. Explain how one would determine the price using present value tables, or by using a calculator.
c) Assuming that interest and discount amortization are recorded each May 31, prepare the adjusting entry at December 31, 2025 (fiscal year end). Round values to the nearest dollar.
Solution 14-91
a) Discount Carrying
Date Cash Paid Interest Expense Amortization Amount of Bonds
Jun 1/23 $438,554
May 31/24 $40,000 $43,855 $3,855 442,409
May 31/25 40,000 44,241 4,241 446,650
May 31/26 40,000 44,665 4,665 451,315
May 31/27 40,000 45,132 5,132 456,447
b) (1) Find the present value of $500,000 due in 10 years at 10%.
(2) Find the present value of 10 annual payments of $40,000 at 10%.
(3) Add (1) and (2) to obtain the present value of the principal and the interest payments.
Calculator: N 10 %i 10 PMT 40000 FV 500000 CPT PV
c) Interest Expense *26,055
Interest Payable **23,333
Bonds Payable 2,722
*7 ÷ 12 × $44,665 (from Table) = $26,055
**7 ÷ 12 × 8% × $500,000 = $23,333
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-92 Bond interest and discount amortization
On October 1, 2023, Irvine Corp. issued $400,000 8% bonds, due on October 1, 2028. Interest is to be paid semi-annually on April 1 and October 1. The bonds were sold to yield 10% effective annual interest. Irvine has a calendar year end.
Instructions
a) Complete the following amortization schedule for the dates indicated. Round all answers to the nearest dollar. Use the effective interest method.
Discount Carrying
Cash Paid Interest Expense Amortization Amount of Bonds
Oct 1/23 $369,113
Apr 1/24
Oct 1/24
b) Prepare the adjusting entry required for these bonds at December 31, 2024.
c) Calculate the interest expense to be reported in the income statement for the year ended December 31, 2024.
Solution 14-92
a)
Discount Carrying
Cash Paid Interest Expense Amortization Amount of Bonds
Oct 1/23 $369,113
Apr 1/24 $16,000 $18,456 $2,456 371,569
Oct 1/24 16,000 18,579 2,579 374,148
b) Interest Expense ($374,148 × 10% × 3 ÷ 12) 9,354
Interest Payable (1/2 × $16,000) 8,000
Bonds Payable ($9,354 – $8,000) 1,354
c) $ 9,228 (1/2 of $18,456)
18,579
9,354
$37,161
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-93 Fair value option and calculation
World Vinyl Inc. currently has an outstanding bond liability of $1,250,000. The company’s credit risk has increased and by year end the fair value of the debt, based solely on a change in credit risk, is $1,100,000. World Vinyl is a privately held firm and uses ASPE.
Instructions
a) Record the required entry at year end of World Vinyl is using the fair value option to account for its bond liability.
b) CRITICAL THINKING: The controller is reviewing the year end entries. He has asked you to explain why you used the fair value option instead of the amortized cost model in accounting for long-term debt under ASPE and how this would differ under IFRS.
Solution 14-93
a) Bonds Payable……………….. 150,000
Unrealized Gain or Loss………………….. 150,000
($1,250,000 – $1,100,000 = $150,000)
b) CRITICAL THINKING: Long-term debt is usually accounted for at amortized cost. However, both ASPE and IFRS allow the use of the fair value option, whereby financial instruments are carried at fair (market) value, an option encouraged by standard setters, although the requirements differ.
ASPE allows the use of the fair value option for all financial instruments, with all changes in fair value recognized in net income.
IFRS explicitly requires that the option be used only where fair value results in more relevant information. As well, IFRS 13 requires that non-performance risk (including credit risk) be included in the fair value measurement. This gives rise to a peculiar situation, since, if the credit risk is deemed to be high, the carrying value of the debt should be reduced (e.g., Dr Bond Payable) and a gain recognized. Any such gain is booked to Other Comprehensive Income.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-94 Entries for bonds payable
Prepare the necessary journal entries to record the following transactions relating to the long-term issuance of bonds by Glendale Corp. Show calculations and round to the nearest dollar.
March 1
Issued $200,000 (face value) 8% bonds for $218,040, including accrued interest. Interest is payable semi-annually on December 1 and June 1 with the bonds maturing 10 years from the previous December 1. The bonds are callable at 102.
June 1
Paid semi-annual interest on the bonds. Use straight-line amortization for any premium or discount.
December 1
Paid semi-annual interest on the bonds, and then purchased $100,000 face value bonds at the call price in accordance with the provisions of the bond indenture.
Solution 14-94
March 1
Cash 218,040
Bonds Payable 214,040
Interest Expense ($200,000 × 8% × 3 ÷ 12) 4,000
June 1
Interest Expense 7,640
Bonds Payable ($14,040 × 3 ÷ 117) 360
Cash 8,000
December 1
Interest Expense 7,280
Bonds Payable ($14,040 × 6/117) 720
Cash 8,000
Bonds Payable *106,480
Gain on Redemption of Bonds 4,480
Cash 102,000
*$100,000 plus unamortized premium ($14,040 x 108/117 x 50% = $6,480) = 106,480
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-95 Entries for bonds payable
Prepare journal entries to record the following transactions relating to long-term bonds of Lancaster Inc. Show calculations and round to the nearest dollar.
a) On June 1, 2023, Lancaster Inc. issued $400,000, 6% bonds for $391,760, including accrued interest. The bonds were dated February 1, 2023, and interest is payable semi-annually on February 1 and August 1 with the bonds maturing on February 1, 2033. The bonds are callable at 102.
b) On August 1, 2023, Lancaster paid the semi-annual interest and recorded the amortization of the discount or premium, using straight-line amortization.
c) On February 1, 2025, Lancaster paid the semi-annual interest and recorded amortization of the discount or premium. Assume that a reversing entry was made on January 1, 2025.
d) The company then purchased $240,000 of the bonds at the call price.
Solution 14-95
a) Cash 391,760
Bonds Payable 383,760
Interest Expense ($400,000 × 6% × 4 ÷ 12) 8,000
b) Interest Expense ($400,000 × 6% × 6 ÷ 12) + $280 12,280
Cash 12,000
Bonds Payable ($16,240 × 2 ÷ 116) 280
c) Interest Expense ($12,000 + $840) 12,840
Cash 12,000
Bonds Payable ($16,240 × 6 ÷ 116) 840
d) Bonds Payable *231,936
Loss on Bond Redemption 12,864
Cash 244,800
*$240,000 less unamortized Discount ($16,240 x 96 ÷ 116 x 60% = $8,064) = $231,936
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-96 Accounting for bond issuance and gain on retirement
Twilight Corp. wanted to raise cash to fund its expansion by issuing long-term bonds. The corporation hired an investment banker to manage the issue (best efforts underwriting) and also hired the services of a lawyer and an audit firm. On June 1, 2023, Twilight sold $500,000 in long-term bonds. The bonds will mature in 10 years and have a stated interest rate of 10%. Other bonds that Twilight has issued with identical terms are traded based on a market rate of 8%. The bonds pay interest semi-annually on May 31 and November 30. The bonds are to be accounted for using the effective interest method. On June 1, 2025, Twilight decided to retire 20% of the bonds. At that time the bonds were selling at 102.
Instructions (Round all values to the nearest dollar)
a) Prepare the journal entry for the issuance of the bonds on June 1, 2023.
b) What was the interest expense related to these bonds that would be reported on Twilight’s calendar 2023 income statement?
c) Prepare all entries from after the issue of the bond until December 31, 2023.
d) Calculate the gain or loss on the partial retirement of the bonds on June 1, 2025.
e) Prepare the journal entry to record the partial retirement on June 1, 2025.
Solution 14-96
PV of bonds (i.e., selling price) N 20, I/Y 4, PMT 25,000 (500,000x 5%), FV 500,000
CPT PV => $567,952
a)
Cash 567,952
Bonds Payable 567,952
b)
Date | Cash | Interest Expense | Discount Amortization | Carrying Value of Bonds |
June 1/23 | 567,952 | |||
Nov. 30/23 | 25,000 | 22,718 | 2,282 | 565,670 |
May 31/24 | 25,000 | 22,627 | 2,373 | 563,297 |
Nov. 30/24 | 25,000 | 22,532 | 2,468 | 560,829 |
May 31/25 | 25,000 | 22,433 | 2,567 | 558,262 |
Interest expense for 2023 = $22,718 + (1 ÷ 6 x $22,627) = $26,489
c)
Nov 30/23
Interest Expense 22,718
Bonds Payable 2,282
Cash 25,000
Dec 31/23
Interest Expense (1 ÷ 6 x $22,627) 3,771
Bonds Payable 396
Interest Payable (1 ÷ 6 x $25,000) 4,167
d) Per the amortization table in part b), the carrying value of the bond as of May 31, 2025 is $558,262.
Cost to repurchase ($500,000 x 20% x 1.02) $102,000
Bond carrying value ($558,262 x 20%) 111,652
Gain on bond redemption $ 9,652
e)
Bonds Payable 111,652
Gain on Redemption of Bonds 9,652
Cash 102,000
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-97 Accounting for bond issuance and loss on retirement
Twilight Corp. wanted to raise cash to fund its expansion by issuing long-term bonds. The corporation hired an investment banker to manage the issue (best efforts underwriting) and also hired the services of a lawyer and an audit firm. On June 1, 2023, Twilight sold $500,000 in long-term bonds. The bonds will mature in 10 years and have a stated interest rate of 8%. Other bonds that Twilight has issued with identical terms are traded based on a market rate of 10%. The bonds pay interest semi-annually on May 31 and November 30. The bonds are to be accounted for using the effective interest method. On June 1, 2025 Twilight decided to retire 20% of the bonds. At that time the bonds were selling at 98.
Instructions (Round all values to the nearest dollar)
a) Prepare the journal entry for the issuance of the bonds on June 1, 2023.
b) What was the interest expense related to these bonds that would be reported on Twilight’s calendar 2023 income statement?
c) Prepare all entries from after the issue of the bond until December 31, 2023.
d) Calculate the gain or loss on the partial retirement of the bonds on June 1, 2025.
e) Prepare the journal entries to record the partial retirement on June 1, 2025.
Solution 14-97
PV of bonds (i.e., selling price) N 20 %i 5 PMT 20,000 (500,000x 4%) FV 500,000
CPT PV => $437,689
a)
Cash 437,689
Bonds Payable 437,689
b)
Date | Cash | Interest Expense | Discount Amortization | Carrying Value of Bonds |
Jun 1/23 | 437,689 | |||
Nov 30/23 | 20,000 | 21,885 | 1,885 | 439,574 |
May 31/24 | 20,000 | 21,979 | 1,979 | 441,553 |
Nov 30/24 | 20,000 | 22,078 | 2,078 | 443,631 |
May 31/25 | 20,000 | 22,182 | 2,182 | 445,813 |
Interest expense for 2023 = 21,885 + (1 ÷ 6 x 21,979) = 25,548
c)
Nov 30/23
Interest Expense 21,885
Cash 20,000
Bonds Payable 1,885
Dec 31/23
Interest Expense (1 ÷ 6 x $21,979) 3,663
Interest Payable (1 ÷ 6 x $20,000) 3,333
Bonds Payable 330
d) Per the amortization table in part b), the carrying value of the bond as of May 31, 2025 is $445,811.
Cost to repurchase ($500,000 x 20% x.98) $98,000
Bond carrying value ($445,813 x 20%) 89,163
Loss on bond redemption $(8,837)
e)
Bonds Payable 89,163
Loss on Redemption of Bonds 8,837
Cash 98,000
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
Pr. 14-98 Bond accounting, ratios, debt covenants
Superior Equipment Corporation is a public Canadian company manufacturing high-precision equipment. On January 1, 2020, Superior issued a 12%, $10,000,000 bond, maturing in ten years. At January 1, 2023, the bond had a carrying value of $9,300,000. Interest is payable semi-annually on June 30 and December 31. The company uses the straight-line method of amortizing any bond premium or discount.
The bond carries covenants that call for the firm’s debt to total assets ratio to be no higher than 50% and their times interest earned ratio to be at least 2.
You are the CEO of Superior. You have been on the job for a year after the previous CEO was fired for missing earnings targets. You are an MBA with a major in Accounting.
Superior’s business is cyclical and the last two years have been tough. In recent months however, there have been signs of recovery in the industry, and many distributors have placed large orders for Superior’s equipment. Delivery of the equipment is expected in 2024 and 2025. You are under pressure from the board of directors to show improvement in the bottom line.
It is now November 30, 2023, and you have just met with the company’s CFO, Ms. Grimm. In preparation for the coming year end on December 31, 2023, she has prepared forecasted financial statements, but has not included the effects of the $10,000,000 bond issue.
Below is a summary of those statements:
Income Statement
Sales $28,000,000
COGS 20,000,000
Gross profit 8,000,000
Operating expenses 5,465,000
Operating income before interest expense 2,535,000
Interest expense ?
Income before income tax ?
Income tax (35%) ?
Net income ?
Statement of financial position
Current assets $14,700,000
Non-current assets 22,000,000
Total assets $36,700,000
Current liabilities 9,000,000
Bonds payable ?
Shareholders’ equity ?
Total liabilities and equity $36,700,000
Additional information:
- Except for the bond, the company did not incur any other interest expense.
- The last time entries were recorded for the bond was at the end of the third quarter (September 30, 2023), when adjusting entries were prepared.
Instructions
a) Prepare the journal entry related to the bond payable for the last quarter of 2023. The entry should reflect the payment of interest and related amortization of the premium or discount.
b) Complete the forecasted financial statements for December 31, 2023 by including the effects of the bond payable.
c) Using the financial statements from part b), calculate the times interest earned and debt to total assets ratios.
d) CRITICAL THINKING: The CEO has asked to you to provide a comprehensive written report with your recommendations based on your financial analysis. Is Superior forecasted to be in violation of the debt covenants? If yes, what action(s) would you recommend? Discuss the advantages/disadvantages of each recommendation.
Solution 14-98
a) The interest to be paid on December 31, 2023 is $600,000 ($10,000,000 x12% x 6 ÷ 12). Half of this is to be recorded as interest expense for this quarter. Amortization of the premium is $100,000 per year, $25,000 for the fourth quarter.
On September 30, 2023, at the end of the third quarter, the following entry would have been posted:
Interest Expense 325,000
Interest Payable 300,000
Bond Payable 25,000
On December 31, 2023, Superior should post the following entry:
Interest Expense 325,000
Interest Payable 300,000
Cash 600,000
Bond Payable 25,000
b)
Income Statement
Sales $28,000,000
COGS 20,000,000
Gross profit 8,000,000
Operating expenses 5,465,000
Operating income before interest expense 2,535,000
Bond interest expense 1,300,0001
Income before income tax 1,235,000
Income tax (35%) 432,2502
Net Income $ 802,750
Interest expense = ($10,000,000 x 12%) + $100,000 = $1,300,000
2 Income tax = $1,235,000 x 35% = $432,250
Statement of financial position
Current assets 14,100,0003
Non-current assets 22,000,000
Total assets 36,100,000
Current Liabilities 8,700,000
Bonds payable 9,400,0004
Shareholders’ equity 18,000,000 (plug number)
Total liabilities and equity 36,100,000
3 Current assets = $14,700,000 – $600,000 = $14,100,000
4 Bonds payable = carrying value Jan. 1/20 + 2023 amortization
= $9,300,000 +$100,000 = $9,400,000
c) Times Interest Earned = Income before income taxes and interest = $2,535,000 = 1.95
Interest Expense $1,300,000
Debt to Total Assets = Total debt = ($8,700,000 +$ 9,400,000) = $18,100,000 = 0.5014
Total assets $36,100,000 $36,100,000
d) CRITICAL THINKING: Superior is forecasted to be in violation of the debt covenant. However, the ratios are very close to the minimum requirements. Your report may recommend the following:
1. Do nothing and run the risk of a default on the bond, or possibly run the risk of a negative stock-market reaction for being in violation of the covenants.
2. Meet the creditors, present your case of expected economic recovery and ask them to wait one more quarter before acting or to waive the covenants for a short period.
3. Renegotiate with the creditors.
The above options might be challenging given the need to convince many creditors and the possible market reaction.
4. If these are callable bonds or they can be purchased on the open market, buy some of them back to extinguish some of the debt, which will also reduce the related interest expense.
5. Sell some operating assets that will yield a gain and use the proceeds to lower debt. For example, using the proceeds to pay your suppliers earlier may improve relations if a potential debt restructuring is to be negotiated.
6. Apply earnings management techniques to increase earnings and total assets. For example, cut back on discretionary expenses such as advertising, repairs and maintenance, and promotion.
Option 4 might help to avoid the debt to total assets ratio violation, but might be too late to avoid interest expense and the violation of the times interest earned ratio violation.
Difficulty: Medium
Learning Objective: Understand how long-term debt is measured and accounted for.
Section Reference: Measurement
Learning Objective: Explain how long-term debt is presented, disclosed and analyzed.
Section Reference: Presentation, Disclosure, and Analytics
CPA: Financial Reporting
Bloomcode: Analysis
AACSB: Analytic
Pr. 14-99 Accounting for a troubled debt settlement
Santa Ltd., who owes Claus Corp. $600,000 in notes payable, is in financial difficulty. To eliminate the debt, Claus agrees to accept from Santa land having a fair value of $455,000 and a recorded cost of $340,000.
Instructions
a) Calculate the amount of gain or loss to Santa on the transfer (disposition) of the land.
b) Calculate the amount of gain or loss to Santa on the settlement of the debt.
c) Prepare the journal entry on Santa's books to record the settlement of the debt.
d) Calculate the gain or loss to Claus from settlement of the receivable from Santa.
e) Prepare the journal entry on Claus's books to record the settlement of the receivable.
Solution 14-99
a) Fair value of land $455,000
Cost of land to Santa 340,000
Gain on disposition of land $115,000
b) Carrying amount of debt $600,000
Fair value of land given 455,000
Gain on settlement of debt $145,000
c) Notes Payable 600,000
Land 340,000
Gain on Disposal of Land 115,000
Gain on Settlement of Debt 145,000
d) Carrying amount of receivable $600,000
Land received in settlement 455,000
Loss on settlement of debt $145,000
e) Land 455,000
Loss on Settlement of Debt 145,000
Notes Receivable 600,000
Difficulty: Medium
Learning Objective: Understand when long-term debt is recognized and derecognized, including how to account for troubled debt restructurings.
Section Reference: Recognition and Derecognition
CPA: Financial Reporting
Bloomcode: Application
AACSB: Analytic
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Test Bank Intermediate Accounting v2 13e | Canada
By Donald E. Kieso