Practice Problems: Bonds
| Site: | Saylor Academy |
| Course: | BUS103: Introduction to Financial Accounting |
| Book: | Practice Problems: Bonds |
| Printed by: | Guest user |
| Date: | Wednesday, April 24, 2024, 7:55 AM |
Description
Complete the demo problem, and self test true/false and multiple choice questions. Check your answers at the end after you finish.
Demonstration problem
Jackson Company issued USD 100,000 face value of 15 percent, 20-year junk bonds on 2010 April 30. The bonds are dated 2010 April 30, call for semiannual interest payments on April 30 and October 31, and are issued to yield 16 percent (8 percent per period).
a. Compute the amount received for the bonds.
b. Prepare an amortization schedule. Enter data in the schedule for only the first two interest periods. Use the effective interest rate method.
c. Prepare journal entries to record issuance of the bonds, the first six months' interest expense on the bonds, the adjustment needed on 2010 December 31 (assuming Jackson's accounting year ends on that date), and the second six months' interest expense on 2011 April 30.
Source: Textbook Equity, https://learn.saylor.org/pluginfile.php/41429/mod_resource/content/15/AccountingPrinciples2.pdf
This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License.
Solution
a.
| Price received: | |
| Present value of principal: $100,000 x 0.04603 (see Appendix, Table A.3, 40 period row, 8% column) | $ 4,603 |
| Present value of interest: $7,500 x 11.92461 (see Appendix, Table A.4, 40 period row, 8% column) | 89,435 |
| Total | $94,038 |
b.
| (A) Interest Payment Date | (B) Bond Interest Expense Debit (E X 0.16 x ½) |
(C) Cash Credit ($100,000 x 0.15 x ½) |
(D) Discount on Bonds Payable Credit (B - C) |
(E) Carrying Value of Bonds Payable (previous balance in E + D) |
|---|---|---|---|---|
| Issued price | $94,038 | |||
| 2010/10/31 | $7,523 | $7,500 | $23 | |
| 2011/4/30 | 7,525 | 7,500 | 25 |
c.
| 2010 Apr. 30 | Cash | 94,038 | |
| Discount on bonds payable | 5,962 | ||
| Bonds payable | 100,000 | ||
| Issued $100,000 face value of 20-year, 15% bonds to yield 16%. | |||
| Oct. 31 | Bond interest expense | 7,523 | |
| Discount on bonds payable | 23 | ||
| Cash | 7,500 | ||
| Paid semiannual bond interest expense. | |||
| Dec. 31 | Bond interest expense ($7,525 x (1/3)) | 2,508 | |
| Discount on bonds payable | 8 | ||
| Bond interest payable ($7,500 x (1/3)) | 2,500 | ||
| To record accrual of two months' interest expense. | |||
| 2011 Apr. 30 | Bond interest payable | 2,500 | |
| Bond interest expense ($7,525 x (2/3)) | 5,017 | ||
| Discount on bonds payable | 17 | ||
| Cash | 7,500 | ||
| Paid semiannual bond interest expense. |
Self-test
True-false
Indicate whether each of the following statements is true or false.
1. An unsecured bond is called a debenture bond.
2. Callable bonds may be called at the option of the holder of the bonds.
3. Favorable financial leverage results when borrowed funds are used to increase earnings per share of common stock.
4. If the market rate of interest exceeds the contract rate, the bonds are issued at a discount.
5. The straight-line method of amortization is the recommended method.
Multiple-choice
Select the best answer for each of the following questions.
1. Harner Company issued USD 100,000 of 12 percent bonds on 2010 March 1. The
bonds are dated 2010 January 1, and were issued at 96 plus accrued interest. The
entry to record the issuance would be:
a.
| Cash | 98,000 | |
| Discount on bonds payable | 4,000 | |
| Bonds payable | 100,000 | |
| Bonds interest payable | 2,000 |
b.
| Cash | 102,000 | |
| Bonds payable | 100,000 | |
| Bond interest payable |
2,000 |
c.
| Cash | 96,000 | |
| Discount on bonds payable | 4,000 | |
| Bond interest payable | 100,000 |
d. None of the above
2. If the bonds in the first question had been issued at 104, the entry to record the issuance would have been:
a.
| Cash | 104,000 | |
| Bonds payable | 100,000 | |
| Premium on bonds payable | 4,000 |
b.
| Cash | 102,000 | |
| Bonds payable | 100,000 | |
| Bonds interest payable | 2,000 |
c.
| Cash | 106,000 | |
| Bonds payable | 100,000 | |
| Premium on bonds payable | 4,000 | |
| Bonds interest payable | 2,000 |
d. None of the above
3. On 2010 January 1, the Alvarez Company issued USD 400,000 face value of 8 percent, 10-year bonds for cash of USD 328,298, a price to yield 11 percent. The bonds pay interest semiannually and mature on 2020 January 1. Using the effective interest rate method, the bond interest expense for the first six months of 2010 would be:
a. USD 36,113.
b. USD 18,056.
c. USD 32,000
d. USD 16,000.
4. If the straight-line amortization method had been used in the previous question, the interest expense for the first six months would have been:
a. USD 39,170.
b. USD 32,000.
c. USD 18,000
d. USD 19,585.
5. Assume a company has net income of USD 100,000, income tax expense of USD 40,000, and interest expense of USD 20,000. The times interest earned ratio is:
a. 5 times.
b. 7 times.
c. 8 times.
d. 9 times.
Answers
True-false
1. True. These unsecured bonds are called debenture bonds and are backed only by the general creditworthiness of the issuer.
2. False. Callable bonds may be called at the option of the issuer.
3. True. This statement is the definition of favorable financial leverage. However, unfavorable financial leverage can result when favorable financial leverage was planned. Unfavorable financial leverage will result if income before interest and taxes is much lower than anticipated. Then earnings per share for the common stockholders would be lower than they would have been without the borrowing.
4. True. Purchasers will not be willing to pay the face amount if the market rate of interest exceeds the contract rate. By paying less than the face value, purchasers can earn the market rate of interest on the bonds.
5. False. The effective interest rate method is the recommended method. The straight-line method may be used only when the results are not materially different from the interest method.
Multiple-choice
1. a. The discount of USD 4,000 must be recorded. Also, the accrued interest must be recognized (USD 100,000 X 12 percent X 2/12 = USD 2,000).
2. c. The premium is USD 4,000, and the accrued interest is USD 2,000. Both must be recognized.
3. b. The interest is (USD 328,298 X 0.11 X 1/2 ) = USD 18,056.
4. d. The interest would have been (USD 400,000 X 0.04) + (USD 71,702/20) = USD 19,585.
5. c. Income before interest and taxes is (USD 100,000 + USD 40,000 + USD 20,000) = USD 160,000. This total of USD 160,000 divided by interest of USD 20,000 = 8 times.