Problem Set – Long-Term Liabilities | Test Bank 10th

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Student name:__________

FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question.
1) _______________ bonds have specific assets of the issuer pledged as collateral.

2) ______________ bonds are bonds that mature on one specified date.

3) _______________ bonds are bonds that mature at more than one date, often in a series, and thus are usually repaid over a number of periods.

4) ____________________ bonds reduce a bondholder's risk by requiring the issuer to set aside assets to pay bond debt.

5) Bonds payable to whoever holds them are called _________________ bonds.

6) _____________________ bonds can be exchanged for a fixed number of shares of the issuing corporation's stock.

7) ___________________ bonds give the issuer the option to retire them at a stated dollar amount before maturity.

8) The legal contract between the issuer and the bondholders is called the ____________________________________.

9) An ________________________________ is a liability requiring a series of payments to the lender.

10) When applying equal total payments to a note, with each payment the amount applied to the note principal ____________ while the interest expense for the note _____________.

11) The bond issuer pays the bond’s interest rate, known as the ____________ .

12) The issue price of bonds is the _______________ of the bonds’ cash payments, discounted at the bonds’ market rate.

13) A _______________________ is an agreement for an employer to provide benefits (payments) to employees after they retire.

14) _________________________ leases are long-term leases that do not meet any of the five criteria for finance leases.

15) ____________________ leases are long-term leases where the lessee receives substantially all remaining benefits of an asset.

16) Bonds that have interest coupons attached to them are known as __________________.

17) Bonds issued in the names and addresses of their holders are ________________ bonds.

18) The ______________ ratio is a measure used to assess the risk of a company's financing structure.

19) The rate of interest that borrowers are willing to pay and lenders are willing to accept for a particular bond and its risk level is the ____________________ of interest.

20) The _________________________ method of amortizing a bond discount allocates an equal portion of the total bond interest expense to each interest period.

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
21) What is a bond? Identify and discuss the different characteristics and features bonds may possess.

22) Describe installment notes and the nature of the equal total payment pattern.

23) On January 1, a company borrowed $70,000 cash by signing a 9% installment note that is to be repaid with 4 equal year-end payments of $21,607. The amount borrowed is $70,000 and 4 years of interest at 9% equals $25,200, for a total of $95,200, yet the total payments on the note amount to only $86,428. Explain.

24) How is the issue price of a bond calculated?

25) What is a lease? Explain the difference between an operating lease and a finance lease.

26) Identify the advantages and disadvantages of bond financing.

27) Describe the journal entries required to record the issuance of bonds at par and the payment of bond interest.

28) Describe the journal entries required to record the issuance of bonds at a premium and the payment of bond interest, including any applicable amortization.

29) Describe the journal entries required to record the issuance of bonds at a discount and the payment of bond interest, including any applicable amortization.

30) Explain the amortization of a bond discount. Identify and describe the amortization methods available.

31) How are bond issue prices determined?

32) Explain the amortization of a bond premium. Identify and describe the amortization methods available.

33) What are methods that a company may use to retire its bonds?

34) Describe the recording procedures for the issuance, retirement, and payment of interest for installment notes.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.
35) Belkin currently has $250,000 of equity and is planning a $100,000 expansion to meet increasing demand for its electronics. Belkin currently earns $70,000 in net income, and the expansion will yield $35,000 in additional income before any interest expense. The company is considering three separate options: (1) do not expand, (2) expand and issue $100,000 in debt that requires payments of 10% annual interest, or (3) expand and raise $100,000 from equity financing. For each option compute (a) net income and (b) return on equity (Net income ÷ Equity).

36) On January 1, Sustainable Energy Corporation issues bonds with a par value of $5,000,000. The bonds are issued at par, mature in 6 years, and pay 8% interest. Interest payments are made semiannually on June 30 and December 31. How much interest does the company pay in cash to bondholders every six months?

37) AMD Corporation issues 8%, 10-year bonds with a par value of $500,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 10%, which implies a selling price of 87 ½. Prepare the journal entry for the issuance of the bonds for cash on January 1.

38) Excel Corporation issues 10%, 15-year bonds with a par value of $480,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 8%, which implies a selling price of 117 ¼. Prepare the journal entry for the issuance of these bonds for cash on January 1.

39) On January 1, the Rodrigues Corporation leased some equipment on a 2-month lease, paying $1,500 per month. The lease is considered to be a short-term lease. Prepare the general journal entry to record the second lease payment on February 1.

40) On January 1, Haymark Corporation signs a six-year lease for a truck that is accounted for as a finance lease. The lease requires six $15,252 lease payments (the first at the beginning of the lease and the rest at December 31 of years 1 through 5). The present value of the six annual lease payments, at 6% interest, is $79,500. The lease payment schedule follows.

(a) Prepare the January 1 journal entry at the start of the lease to record any asset or liability.
(b) Prepare the January 1 journal entry to record the first $15,252 cash lease payment.
(b) Prepare the journal entry to record the cash lease payment at the end of Year 1 and the end of Year 2.
(c) Prepare the journal entry made at the end of each year to record straight-line amortization, assuming zero salvage value at the end of the six-year lease term.

41) Sharma Company's balance sheet reflects total assets of $250,000 and total liabilities of $150,000. Calculate the company's debt-to-equity ratio.

42) On July 1 of the current year a corporation issued (sold) $1,000,000 of its 12% bonds at par. The bonds pay interest June 30 and December 31. What amount of bond interest expense should the company report on its current year income statement?

43) Johanna Corporation issued $3,000,000 of 8%, 20-year bonds payable at par value on January 1. Interest is payable each June 30 and December 31.
(a) Prepare the general journal entry to record the issuance of the bonds on January 1.
(b) Prepare the general journal entry to record the first interest payment on June 30.

44) A company issued 9%, 10-year bonds with a par value of $100,000. Interest is paid semiannually. The market interest rate on the issue date was 10%, and the issuer received $95,016 cash for the bonds. On the first semiannual interest date, what amount of cash should be paid to the holders of these bonds for interest?

45) On January 1, a company issued 10-year, 10% bonds payable with a par value of $500,000, and received $442,647 in cash proceeds. The market rate of interest at the date of issuance was 12%. The bonds pay interest semiannually on July 1 and January 1. The issuer uses the straight-line method for amortization. Prepare the issuer's journal entry to record the first semiannual interest payment on July 1.

46) A company issued 10-year, 9% bonds, with a par value of $500,000 when the market rate was 9.5%. The issuer received $484,087 in cash proceeds. Prepare the issuer's journal entry to record the bond issuance.

47) A company issued 10-year, 9% bonds with a par value of $500,000 when the market rate was 9.5%. The company received $484,087 in cash proceeds. Using the straight-line method, prepare the issuer's journal entry to record the first semiannual interest payment and the amortization of any bond discount or premium.

48) A company issues 6%, 5-year bonds with a par value of $800,000 and semiannual interest payments. On the issue date, the annual market rate of interest is 8%. Compute the issue (selling) price of the bonds. The following information is taken from present value tables:

49) A company issued 9.2%, 10-year bonds with a par value of $100,000. Interest is paid semiannually. The annual market interest rate on the issue date was 10%, and the issuer received $95,016 cash for the bonds. The issuer uses the effective interest method for amortization. On the first semiannual interest date, what amount of discount should the issuer amortize?

50) A company issued 10%, 10-year bonds with a par value of $1,000,000 on January 1, at a selling price of $885,295 when the annual market interest rate was 12%. The company uses the effective interest amortization method. Interest is paid semiannually each June 30 and December 31.

(1) Prepare an amortization table for the first two payment periods using the format shown below:

(2) Prepare the journal entry to record the first semiannual interest payment.

51) A company issued 10-year, 9% bonds with a par value of $500,000 when the market rate was 9.5%. The company received $484,087 in cash proceeds. Using the effective interest method, prepare the issuer's journal entry to record the first semiannual interest payment and the amortization of any bond discount or premium. (Round answers to the nearest dollar)

52) A company issued 10-year, 9% bonds with a par value of $500,000 when the market rate was 9.5%. The company received $484,087 in cash proceeds. Prepare the issuer's journal entry to record the issuance of the bond.

53) On January 1, a company issued 10%, 10-year bonds payable with a par value of $720,000. The bonds pay interest on July 1 and January 1. The bonds were issued for $817,860 cash, which provided the holders an annual yield of 8%. Prepare the journal entry to record the first semiannual interest payment, assuming it uses the straight-line method of amortization.

54) On January 1, a company issues 8%, 5-year, $300,000 bonds that pay interest semiannually each June 30 and December 31. On the issue date, the annual market rate of interest is 6%. Compute the price of the bonds on their issue date. The following information is taken from present value tables:

55) On January 1, a company issues 8%, 5-year, $300,000 bonds that pay interest semiannually each June 30 and December 31. On the issue date, the annual market rate of interest for the bonds is 10%. Compute the price of the bonds on their issue date. The following information is taken from present value tables:

56) On January 1, a company issues 6%, 10-year $300,000 par value bonds that pay semiannual interest each June 30 and December 31. The bonds sell at par value. Prepare the general journal entry to record the issuance of the bonds on January 1.

57) On April 1, a company issues 6%, 10-year, $600,000 par value bonds that pay interest semiannually each March 31 and September 30. The bonds sold at $592,000. The company uses the straight-line method of amortizing bond discounts. Prepare the general journal entry to record the first interest payment on September 30.

58) Strider Corporation issued 14%, 5-year bonds with a par value of $5,000,000 on January 1, Year 1. Interest is to be paid semiannually on each June 30 and December 31. The bonds are issued at $5,368,035 cash when the market rate for this bond is 12%.
(a) Prepare the general journal entry to record the issuance of the bonds on January 1, year 1.
(b) Show how the bonds would be reported on Strider’s balance sheet at January 1, Year 1.
(c) Assume that Strider uses the effective interest method of amortization of any discount or premium on bonds. Prepare the general journal entry to record the first semiannual interest payment on June 30, Year 1.
(d) Assume instead that Strider uses the straight-line method of amortization of any discount or premium on bonds. Prepare the general journal entry to record the first semiannual interest payment on June 30, Year 1.

59) On January 1, a company issued 10%, 10-year bonds with a par value of $720,000. The bonds pay interest each July 1 and January 1. The bonds were sold for $817,860 cash, based on an annual market rate of 8%. Prepare the issuer's journal entry to record the first semiannual interest payment assuming the effective interest method is used.

60) A company issued 10%, 5-year bonds with a par value of $2,000,000, on January 1. Interest is to be paid semiannually each June 30 and December 31. The bonds were sold at $2,162,290 based on an annual market rate of 8%. The company uses the effective interest method of amortization.

(1) Prepare an amortization table for the first two semiannual payment periods using the format shown below. (Round answers to the nearest cent)
(2) Prepare the journal entry to record the first semiannual interest payment.

61) A company holds $150,000 par value of bonds with a carrying value of $147,950. The company calls the bonds at $151,000. Prepare the journal entry to record the retirement of the bonds.

62) A company has 10%, 20-year bonds outstanding with a par value of $500,000. The company calls the bonds at $480,000 when the unamortized discount is $24,500. Calculate the gain or loss on the retirement of these bonds.

63) Mandarin Company has 9%, 20-year bonds outstanding with a par value of $500,000 and a carrying value of $475,000. The company calls the bonds at $482,000. Calculate the gain or loss on the retirement of these bonds.

64) A company previously issued $2,000,000, 10% bonds, receiving a $120,000 premium. On the current year's interest date, after the bond interest was paid and after 40% of the total premium had been amortized, the company calls the bonds at $1,960,000. Prepare the journal entry to record the retirement of these bonds on January 1 of the current year.

65) On January 1, Year 1 a company borrowed $70,000 cash by signing a 9% installment note that is to be repaid with 4 annual year-end payments of $21,607, the first of which is due on December 31, Year 1.
(a) Prepare the company's journal entry to record the note's issuance.
(b) Prepare the journal entries to record the first and second installment payments.

66) On January 1, a company borrowed $50,000 cash by signing a 7% installment note that is to be repaid in 5 annual end-of-year payments of $12,195. The first payment is due on December 31. Prepare the journal entries to record the first and second installment payments.

67) On January 1, Year 1 Cleaver Company borrowed $85,000 cash by signing a 7% installment note that is to be repaid with 4 annual year-end payments of $25,094, the first of which is due on December 31, Year 1.
(a) Prepare the company's journal entry to record the note's issuance.
(b) Prepare the journal entries to record the first installment payment.

68) A company purchased two new delivery vans for a total of $250,000 on January 1, Year 1. The company paid $40,000 cash and signed a $210,000, 3-year, 8% note for the remaining balance. The note is to be paid in three annual end-of-year payments of $81,487 each, with the first payment on December 31, Year 1. Each payment includes interest on the unpaid balance plus principal.

(1) Prepare a note amortization table using the format below: (Round answers to the nearest dollar)

(2) Prepare the journal entries to record the purchase of the vans on January 1, Year 1 and the second annual installment payment on December 31, Year 2.

Answer Key

Test name: John Wild Ch10 Problem Material

1) Secured

2) Term

3) Serial

4) Sinking fund

5) bearer

6) Convertible

7) Callable

8) bond indenture

9) installment note

10) [increases, decreases]

11) contract rate

12) present value

13) pension plan

14) Operating

15) Finance

16) coupon bonds

17) registered

18) debt-to-equity

19) market rate

20) straight-line

21) A bond is a written promise to pay an amount identified as the par value of the bond along with interest at a stated contract rate. Bonds can be issued by companies or governments. Bonds are usually issued in denominations of $1,000 or $5,000. Bonds can be secured or unsecured. Secured bonds are backed by collateral or assets of the issuer. Bonds can mature in different ways. Serial bonds mature at different points in time, while term bonds mature at a single date. Registered bonds are payable to a specific bondholder, while bearer or coupon bonds are payable to whoever holds the bonds. Convertible bonds may be exchanged by bondholders for shares of the issuing company's stock. Callable bonds can be retired prior to the maturity date by the issuer.

22) Installment notes are agreements to repay borrowed amounts over several periods through a series of payments to the lender. The most common type of note requires an equal payment which is allocated between principal and interest. With equal total payments, the cash payment remains constant over the life of the note while the amount applied to principal increases over time and the amount of interest expense decreases over time.

23) Payments on an installment note include payments toward the amount borrowed (principal) as well as accrued interest on the loan. Because part of the principal is paid each year, the carrying value declines and the amount of interest decreases accordingly with the decreasing principal amount outstanding each year.

24) A bond’s issue price is the present value of the bond’s cash payments, discounted at the bond’s market rate. The computation of a bond’s issue price consists of two parts. First, the present value of the bond’s par value must be computed. Second the present value of the bond’s semiannual payments must be determined. These two figures are then added together to determine the issue price. Present value calculations can be accomplished with a calculator, Excel, or through the use of present value tables.

25) A lease is a contractual agreement between a lessor (asset owner) and a lessee (asset renter or tenant) that grants the lessee the right to use the asset for a period of time in return for cash (rent) payments. Operating leases are long-term leases that do not meet any of the five criteria for a finance lease. Finance leases are long-term leases where the lessee receives substantially all remaining benefits of the asset. The lessee records the leased item as its own asset along with a lease liability at the start of the lease term. Each payment includes interest expense plus a payment on the lease liability. The lessee records amortization expense on the leased asset.

26) The advantages of bond financing include tax deductible interest, no effect on owner control, and potentially increased return on equity due to financial leverage. Disadvantages include required repayment of principal, interest payments, and the risk of decreased return on equity when the company earns a lower return on the borrowed funds than it pays in interest.

27) The journal entry to record a bond issuance at par includes a debit to Cash for the amount of the proceeds and a credit to Bonds Payable for the amount of the par value of the bonds. At the time of each interest payment, the Interest Expense account is debited and the Cash account is credited for the amount of the stated (contract) interest.

28) The journal entry to record a bond issuance at a premium includes a debit to Cash for the amount of the proceeds, a credit to Bonds Payable for the amount of the par value of the bonds, and a credit to the Premium on Bonds Payable for the difference between the issue price and the par value. At the time of each interest payment, the Interest Expense account is debited, Premium on Bonds Payable is debited for the amount of amortization calculated, and the Cash account is credited for the amount of the stated (contract) interest.

29) The journal entry to record a bond issuance at a discount includes a debit to Cash for the amount of the proceeds, a debit to Discount on Bonds Payable for the difference between the issue price and the par value, and a credit to the Bonds Payable account for the par value. At the time of each interest payment, the Interest Expense account is debited, Discount on Bonds Payable is credited for the amount of amortization calculated, and the Cash account is credited for the amount of the stated (contract) interest.

30) A bond discount occurs when bonds are sold for less than their par value. The discount represents additional interest over the life of the bond (the full par value must be paid to bondholders at maturity). The amount of the bond discount is amortized over the life of the bond. One method of amortizing the bond discount is the straight-line method. The amount of discount amortized each period is the original discount divided by the number of interest periods. Bond interest expense each period is the cash interest payment plus the discount amortized. Another method is the effective interest method. In this case the bond interest expense is calculated by multiplying the bonds' beginning-of-the-period carrying value by the market interest rate for the bond at issuance.

31) The issue price of bonds is found by computing the present value of the bonds' cash payments, discounted at the bond's market rate. If the bond's market rate is greater than the bond's coupon rate, the bond will sell at a discount. If the bond's market rate is less than the bond's coupon rate, the bond will sell at a premium.

32) A bond premium occurs when bonds are sold for more than their par value. The bond premium represents a reduction in the amount of interest owed over the life of the bond. A bond premium is amortized over the life of the bond. One method of amortizing the bond premium is the straight-line method. The premium amortized each period is the original premium divided by the number of interest periods. Bond interest expense each period is the cash interest payment less the premium amortized. Another method is the effective interest method. In this case the bond interest expense is calculated by multiplying the bonds' beginning-of-the-period carrying value by the market interest rate for the bonds at issuance.

33) The company can retire the bonds at their scheduled maturity date. They can also retire the bonds before maturity by either exercising a call option or by purchasing them in the open market at the current market price. Sometimes the bond indenture will give the issuer an option to call the bonds before their maturity date by paying the par value plus a call premium to the bondholder. If the call price or the market price paid is above the carrying value of the bonds, the issuer will record a loss on the early retirement. If the call price or the market price paid is below the carrying value of the bonds, the issuer will record a gain on the early retirement.

34) At issuance, the proceeds from a note must be recognized in the appropriate asset account and the debt must be recognized as a note payable. Each payment includes accrued interest expense plus a portion of the principal amount borrowed. Interest payments are recorded with a debit to Interest Expense, a debit to Notes Payable for the principal paid, and a credit to Cash for the amount of the total payment. The retirement of a note is recognized with a debit to Notes Payable and a credit to Cash (or other asset).

35)

36) $5,000,000 × 0.08 × ½ = $200,000

37)