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Chapter 010: Reporting and Interpreting Bonds

True / False Questions


1. An unsecured bond is usually called an indenture.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

2. The use of financial leverage by a company does not result in increased risk for its
investors.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

3. The major disadvantages of issuing a bond are the risk of bankruptcy and the negative cash
impact on cash flow because debt must be repaid at a specified date in the future.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

4. The market interest rate is almost always less than the stated interest rate on bonds.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 2

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Chapter 010: Reporting and Interpreting Bonds

5. The issuance price of a bond is the discounted present value of both the principal plus the
cash interest to be received over the life of the bonds discounted by the stated or coupon rate.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

6. When the market interest rate is higher than the stated interest rate, a bond can be
purchased at a discount.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

7. Amortization of a discount on a bond payable will make the amount of interest expense
reported on the income statement less than the cash paid for that year.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

8. A bond issued at a discount will pay total cash payments for interest that is more than the
total interest expense recognized over the period the bond is issued.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

9. Either straight-line or effective-interest amortization may be used for bond premiums or


discounts regardless of the amounts involved.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3; 4

10. If a bond is issued at a discount or premium, the amount of annual cash interest paid will
be different than the amount paid by a bond issued at par.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3; 4

11. The end of period adjusting entry required for a bond issued at a premium includes a debit
to the account, Premium on Bonds Payable.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

12. A bond issued at a premium will pay cash interest in excess of the amount of interest
expense recognized for accounting purposes.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

13. For the bondholder (investor), amortization of a bond premium each interest period will
increase the reported amount of interest revenue.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

14. The debt to equity ratio is calculated by dividing total liabilities by total liabilities plus
stockholders' equity.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

15. Companies which are investing heavily in fixed assets and acquiring other companies tend
to use more debt financing.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 5

16. Any gains or losses from early retirement of bonds are included on the income statement.
TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 6

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Chapter 010: Reporting and Interpreting Bonds

17. If a company repurchases $1,000,000 of their bonds for $1,020,000 when their book value
is $950,000, then they will generate a loss of $20,000.
FALSE

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 6

18. Issuance of bonds provides cash inflow from a financing activity.


TRUE

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 7

19. Repayment of the bonds principal when they mature causes a cash outflow connected to
investing activities.
FALSE

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

20. The cash paid for interest must be reported by a company but it can be disclosed in a
variety of locations in the financial reports.
TRUE

AACSB Tag: Communications


Difficulty: Medium
L.O.: 7

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Chapter 010: Reporting and Interpreting Bonds

Multiple Choice Questions


21. When a company prepares a bond indenture, certain provisions of the bonds are included.
Which of the following is/are not specified in the indenture?
A. Dates of each interest payments.
B. Rate of interest to be paid.
C. Maturity date.
D. Cash to be received at the issue date.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

22. A bond contract that specifies the legal provisions of a bond issue is called
A. a junk bond.
B. an indenture.
C. a premium.
D. a risk covenant.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

23. An unsecured bond for which no assets are specifically pledged to guarantee repayment is
called
A. a debenture
B. a callable bond
C. a convertible bond
D. an indenture

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

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Chapter 010: Reporting and Interpreting Bonds

24. Which of the following is not a reason that a corporation would want to issue bonds
instead of stock?
A. Interest payments can be deducted for income tax purposes.
B. Stockholders maintain control.
C. The impact on earnings may be positive.
D. There is less cash outflow resulting from bonds.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 1

25. Bonds payable usually are classified on the balance sheet as


A. long-term liabilities.
B. current liabilities.
C. investments and funds.
D. current assets.

AACSB Tag: Communications


Difficulty: Easy
L.O.: 1

26. The annual interest rate specified on a bond (which is based on the maturity amount of the
bond) appropriately can be called the
A. stated rate.
B. market rate.
C. effective rate.
D. .risk rate.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

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Chapter 010: Reporting and Interpreting Bonds

27. Bonds usually are issued to obtain cash for the purpose of
A. meeting working capital needs.
B. investing in short-term marketable securities.
C. purchasing insurance.
D. acquisitions of long-term assets.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

28. Callable bonds may be


A. turned in for early retirement at the option of the bondholder.
B. converted to common stock at the option of the bondholder.
C. called for early retirement at the option of the issuer.
D. converted to registered bonds at the option of the company president.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

29. Which of the following is a disadvantage to the corporation issuing bonds?


A. The required interest payment due at maturity.
B. The liquid nature of the bonds makes them attractive to investors who may not want to
hold them to maturity.
C. The large principal payment due at maturity.
D. The required dividend payments to bondholders each period.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

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Chapter 010: Reporting and Interpreting Bonds

30. Which of the following is an advantage of issuing bonds versus issuing stock to finance
expansion?
A. Stockholders remain in control as bondholders cannot vote or share in the company's
earnings.
B. Interest expense is tax deductible but dividends are not.
C. Money can usually be borrowed at a lower rate and then invested to earn a higher return on
assets.
D. All answers are advantages.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

31. A bond where no specific assets are pledged to guarantee repayment is called a
A. debenture bond.
B. callable bond.
C. discount bond.
D. convertible bond.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 1

32. Which of the following statements is true?


A. Unsecured debt has a preferential claim against the liquidation of assets in relationship to
other creditor claims.
B. Convertible bonds may be retired before maturity at the option of the issuer.
C. Junk bonds are those with a low rating and because their rating is below investment grade
level, they are considered high risk.
D. Secured debt does not have a preferential claim against the liquidation of assets in
relationship to other creditor claims.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

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Chapter 010: Reporting and Interpreting Bonds

33. Which of the following statements is false?


A. Because junk bonds are higher risk than higher rated investment grade bonds, many banks,
mutual funds and trusts are not allowed to invest in them.
B. Callable bonds can be retired before maturity at the option of the bondholder for a
predetermined cash call price.
C. A debenture bond is one that is not secured by specific assets of the company.
D. A debenture bond is also known as an unsecured bond.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

34. Halverson's times interest earned ratio was 2.98 in 2009, 2.79 in 2008, and 2.31 in 2007.
Which of the following statements about their ratio is correct?
A. Their increasing ratio indicates decreasing levels of debt on which interest is incurred.
B. Their increasing ratio indicates their strategy of pursuing growth by investment in other
companies which has increased debt but their profits have not yet increased from those
investments.
C. The higher ratio was adversely affected by the net loss they reported in 2007.
D. Their increasing ratio would be considered by creditors to be an indicator of higher risk.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 2

35. Which of the following is true?


A. A higher times interest earned ratio could indicate a growing company.
B. A lower times interest earned ratio is desired by creditors.
C. A more important indicator that a company is able to meet its debt obligations would be
the sufficiency of its cash flow from operating activities.
D. A more important indicator that a company is able to meet its debt obligations would be
the sufficiency of the current ratio.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

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Chapter 010: Reporting and Interpreting Bonds

36. In 2009, Patty's Pizza reported net income of $4,212 million, interest expense of $167
million and income tax expense of $1,372 million. In 2008, they reported net income of
$3,568 million, interest expense of $163 million and income tax expense of $1,424 million.
Calculate the times interest earned ratio for 2009and 2008 respectively.
A. 32.2 and 29.4 times
B. 28.4 and 23.8 times
C. 34.4 and 31.6 times
D. 34.1 and 26.6 times

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

37. In 2009, NTV reported a times interest earned ratio of 32.7 times while Home Movie
Channel reported a ratio of 34.4 times. Which of the following statements is true?
A. NTV and Home Movie Channel have more than adequate ratios demonstrating their ability
to cover interest charges with their earnings levels.
B. Home Movie Channel's ratio is significantly higher than NTV's ratio.
C. Lenders would be pleased with the ratios of both companies and be willing to lend them
money for future expansion.
D. All statements are true.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

38. If the market interest rate for a bond is higher than the stated interest rate, the bond will
sell at
A. a discount.
B. a premium.
C. par.
D. the price cannot be determined from the information given.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 2

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Chapter 010: Reporting and Interpreting Bonds

39. On November 1, 2009, Davis Company issued $30,000, ten-year, 7% bonds at 97. The
bonds were dated November 1, 2009, and interest is payable each November 1 and May 1.
The amount of discount amortization at each semi-annual interest date would be (assume
straight-line amortization):
A. $ 50.
B. $100.
C. $600.
D. $450.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

40. Gammell Company issued $50,000 bonds payable, 9% annual interest, maturity in ten
years. The bonds were issued at $48,000. Gammel Company uses straight-line amortization.
The amount of interest expense each full year would be
A. $4,700.
B. $4,300.
C. $4,500.
D. $4,680.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

41. On January 1, 2009, Allison Company issued $600,000, five-year, 8% bonds at $570,000.
The bonds were dated January 1, 2009, and interest is payable each June 30 and December 31.
The company uses the straight-line method of amortization. The amount of the net liability for
bonds payable that would be reported on the December 31, 2009, balance sheet is
A. $600,000.
B. $597,000.
C. $573,000.
D. $576,000.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

42. Moore Company issued $100 million of fixed interest rate bonds payable at $98 million.
At year-end, the bonds were selling in the bond market at $98 million. What entry would
Moore Company make at year-end to record the change in selling price?
A. Debit Bonds Payable $3 million; credit Interest Expense $3 million.
B. Debit Interest Expense $3 million; credit Bonds Payable $3 million.
C. Debit Investment in Bonds $3 million; credit Investment Revenue $3 million.
D. No entry needed.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

43. If a bond payable is issued at a discount, the amount of the carrying value (the long-term
liability) reported on the subsequent balance sheets
A. remains constant.
B. increases each year.
C. decreases each year.
D. changes from year to year depending upon the market rate of interest each year.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

44. On January 1, 2009, Broker Corp. issued $3,000,000 par value 12%, 10 year bonds which
pay interest each December 31. If the market rate of interest was 14%, the issue price of the
bonds should be? (The present value factor for $1 in 10 periods at 12% is .3220 and at 14% is
.2697. The present value of an annuity of $1 factor for 10 periods at 12% is 5.6502 and at
14% is 5.2161.)
A. $3,339,084
B. $2,843,172
C. $3,000,000
D. $2,686,896

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

45. On January 1, 2009, Dorley Corporation issued $1 million of bonds for $1,073,613 when
the market rate of interest was 6%. They are 10-year bonds paying 8% interest annually. If
Dorley Corporation is using the straight-line amortization method, interest expense on
December 31, 2009 will be
A. $ 80,000
B. $ 60,000
C. $ 87,361
D. $ 72,639

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

46. General Tech Corporation issued $30,000 bonds payable, 5% annual interest, due in ten
years. The bonds were issued at $29,400. Assume straight-line amortization. Interest expense
each year would be
A. $1,500.
B. $1,440.
C. $1,560.
D. $1,100.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

47. If a bond is issued at 98, its stated rate of interest would be


A. higher than the market rate.
B. lower than the market rate.
C. equal to the market rate.
D. unrelated to the market rate.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

48. On January 1, 2009, Tonika Corporation issued a four-year, $10,000, 7% bond. The
interest is payable annually each December 31. The issue price was $9,668 based on an 8%
effective interest rate. Assuming effective-interest amortization is used, the interest expense
on the income statement for the year ended December 31, 2009 would be (to the nearest
dollar)
A. $ 1,547.
B. $ 883.
C. $ 773.
D. $ 700.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 3

49. When a bond investment is issued at a discount, subsequent amortization of the discount
A. increases interest expense.
B. decreases interest expense.
C. has no effect upon interest expense.
D. decreases interest in the bond.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

50. Which of the following is true when using the effective interest amortization method when
a bond has been issued at a discount?
A. Interest expense is computed by adding the portion of amortized discount to the cash
interest paid.
B. The amount of interest expense recognized each period increases over time.
C. The amount of discount amortized each period decreases over time.
D. All of the answers are true.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

51. Of the following statements, which is false regarding the effective-interest method of
amortization?
A. The amount of interest expense is different each period.
B. The amount of discount or premium that is amortized is the same each period.
C. The amount of cash interest paid is constant each period.
D. None of the other answers are false.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3; 4

52. Which of the following statements is true?


A. Bonds are always issued at their par value.
B. Bonds issued at more than par value are said to be issued at a discount.
C. Once bonds are issued; the bonds will trade in the bond market above or below par
depending on changes in interest rates.
D. Bondholders must hold their bonds to maturity to receive cash for their investment.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3; 4

53. Eaton Company issued $5 million in bonds. The stated rate of interest was 10% and the
market rate 11%. Which of the following statements is true?
A. The bonds were issued at a premium.
B. Annual interest expense will exceed the company's actual cash payments for interest.
C. Annual interest expense will be $500,000.
D. Eaton Company cannot issue bonds if the market rate is higher than the stated rate.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3; 4

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Chapter 010: Reporting and Interpreting Bonds

54. On January 1, 2009, Jason Company issued $5 million of 10-year bonds at a 10% stated
interest rate to be paid annually. The following present value factors have been provided to
answer the subsequent questions:

Calculate the issuance price if the market rate of interest is 8%.


A. $5,000,000
B. $5,670,000
C. $5,387,500
D. $5,712,500

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

55. On January 1, 2009, Jason Company issued $5 million of 10-year bonds at a 10% stated
interest rate to be paid annually. The following present value factors have been provided to
answer the subsequent questions:

Calculate the issuance price if the market rate of interest is 12%.


A. $4,427,500
B. $4,477,500
C. $4,435,000
D. $5,000,000

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

56. On January 1, 2009, Jason Company issued $5 million of 10-year bonds at a 10% stated
interest rate to be paid annually. The following present value factors have been provided to
answer the subsequent questions:

If Jason issued the bonds for $5,325,000, how much would the premium amortization be on
December 31, 2009 under the straight-line method?
A. $32,500
B. $59,125
C. $16,250
D. $27,956

AACSB Tag: Analytic


Difficulty: Easy
L.O.: 4

57. On January 1, 2009, Jason Company issued $5 million of 10-year bonds at a 10% stated
interest rate to be paid annually. The following present value factors have been provided to
answer the subsequent questions:

How much cash interest would be paid by Jason on December 31, 2009?
A. $500,000
B. $250,000
C. $300,000
D. $200,000

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

58. On January 1, 2009, Jason Company issued $5 million of 10-year bonds at a 10% stated
interest rate to be paid annually. The following present value factors have been provided to
answer the subsequent questions:

If Jason issued the bonds for $5,325,000, the amount of interest expense on December 31,
2009 under the straight-line amortization method equals
A. $567,500
B. $540,875
C. $532,500
D. $490,044

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

59. On January 1, 2009, Jason Company issued $5 million of 10-year bonds at a 10% stated
interest rate to be paid annually. The following present value factors have been provided to
answer the subsequent questions:

If Jason issued the bonds at a price of 106.5, what is the book value of Jason's bonds on
December 31, 2009 after the interest payment assuming the straight-line method is used?
A. $5,297,044
B. $5,292,500
C. $5,265,875
D. $5,308,750

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

60. Skylar Corporation issued $50,000,000 of its 10% bonds at par on January 1, 2009. On
December 31, 2009 the bonds were trading on the bond exchange at 102. Since the issue
date, the market rate of interest on similar risk bonds has
A. Increased.
B. Decreased.
C. Stayed the same.
D. None of the other answers is correct.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 4

61. On July 1, 2009, GardenWorks, Inc. issued 300, $1,000, ten-year, 7% bonds at 101. The
bonds were dated July 1, 2009, and semi-annual interest will be paid each December 31 and
June 30. GardenWorks Inc., uses straight-line amortization. The bond liability that would be
reported on the balance sheet at December 31, 2009, is
A. $300,000.
B. $302,850.
C. $302,700.
D. $303,000.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

62. On July 1, 2009, Jackson Company issued $300,000, five-year, 9% bonds at $309,000.
The reason Jackson Company issued the bonds at a premium was
A. the stated rate of interest was higher than the rate being paid on investments with
comparable risk.
B. the stated rate of interest was the same as the rate being paid on investments with
comparable risk.
C. the stated rate of interest was lower than the rate being paid on investments with
comparable risk.
D. the bonds were callable.

AACSB Tag: Relative Thinking


Difficulty: Easy
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

63. Straight-line amortization of a premium related to a bond issuance would


A. require interest expense be calculated by multiplying the market interest rate times the
book value of the bonds.
B. lead to higher premium amortization in the early years and lower interest expense over the
life of the bonds.
C. require computing the constant amount of premium to be amortized and then deducting it
from cash interest to calculate interest expense.
D. require interest expense be calculated by multiplying the market interest rate times the
book value of the bonds and lead to higher premium amortization in the early years and lower
interest expense over the life of the bonds.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 4

64. The amortization of bond premium by the issuer will


A. increase interest expense.
B. decrease interest expense.
C. have no effect on interest expense.
D. determine the cash paid for interest.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

65. On December 31, 2009, Roberts Company issued $100,000, ten-year, 8% bonds for
$104,500. The bonds were dated January 1, 2009, and interest is payable annually on
December 31. Roberts Company uses the straight-line amortization method. Roberts
Company should report the book value, or carrying value, for the bonds on the December 31,
2009, balance sheet as
A. $100,000.
B. $103,400.
C. $104,000.
D. $104,500.

AACSB Tag: Analytic


Difficulty: Easy
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

66. If a bond is issued at 101, the stated rate of interest was


A. higher than market rate.
B. lower than market rate.
C. equal to market rate.
D. not related to market rate.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 4

67. Mayberry, Inc., issued $100,000 of 10 year, 12% bonds dated April 1, 2009, for $102,360
on April 1, 2009. The bonds pay interest annually on April 1. Straight-line amortization is
used by the company. What entry is needed at April 1, 2010 for the first interest payment?

A.

B.

C.

D.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

68. In 2009, Tommy's Toys had total liabilities of $5,443 million and total assets of $9,768
million. In 2008, their total liabilities were $6,291 million and total assets were $10,265
million. Which of the following statements is true?
A. The company had a decrease in their debt to equity ratio from 2008 to 2009.
B. The company had more creditor financing versus stockholder equity financing in 2009.
C. Their debt to equity ratio in 2009 means they have less than half their financing provided
by creditors.
D. All answers are true.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

69. In 2009, General Tech had a debt to equity ratio of .21 while their competitor in the
biotechnology field, American Bio had a debt to equity ratio of .24. Which of the following
statements is false?
A. General Tech has a larger portion of its assets financed by equity than American Bio does.
B. When compared to General Tech, American Bio's use of more debt funding increases
financial risk and causes their stockholders to have a lower return on equity when return on
assets exceeds the after-tax interest rate.
C. General Tech's ratio implies that less than 20% of its assets are financed by equity.
D. American Bio's ratio implies that less than 25% of its assets are financed by equity.

AACSB Tag: Relative Thinking


Difficulty: Hard
L.O.: 5

70. In 2008, The Mickey Co. had total liabilities of $20,645 million and total assets of
$43,699 million. In 2007, they had total liabilities of $20,918 million and total assets of
$45,027 million. Calculate their debt to equity ratio for 2008 and 2007 respectively.
A. 1.12 and 1.15
B. .90 and .87
C. .47 and .46
D. .52 and .54

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 5

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Chapter 010: Reporting and Interpreting Bonds

71. In 2010, Western Wear Inc. reported total liabilities of $382 million and total
stockholders' equity of $1,967 million. In 2009, their total liabilities were $343 million and
total stockholders' equity was $1,900 million. Which statement about their debt to equity
position is true?
A. While their debt level increased, their debt to equity ratio decreased slightly.
B. Western Wear Inc. has a very low debt to equity ratio.
C. Stockholders' equity increased at a faster rate than the rate of increase in liabilities.
D. All answers are true.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 5

72. If a company retires bonds payable early by purchasing the bonds in the open market,
A. any gain or loss would be reported in the income statement as an extraordinary item.
B. the amount paid would always equal the par value.
C. any unamortized premium or discount would be reclassified to stockholders' equity as
contributed capital.
D. the gain or loss would be presented in the asset section of the balance sheet.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

73. On July 1, 2011, immediately after recording interest payments, Salsa, Inc. retired one
fifth of its $500,000 bonds payable for $97,500. The bonds were originally issued at par value
in 2006. Which statement is correct?
A. Cash of $100,000 will be paid to the bondholders.
B. A gain of $2,500 will be reported in the income statement.
C. A loss of $2,500 will be reported in the income statement.
D. A loss of $2,500 will be reported as a separate component of stockholder's equity in the
balance sheet.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 6

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Chapter 010: Reporting and Interpreting Bonds

74. On the maturity date of bonds payable after interest has been paid, the issuing company
will
A. record a loss if the market rate of interest on the maturity date exceeds the stated rate of
interest.
B. pay bondholders the original amount the bondholders paid to purchase the bonds.
C. debit Bonds Payable and credit Cash for the par value of the bonds.
D. debit Cash and credit Bonds Payable for the carrying amount of the bonds.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

75. Which of the following is true?


A. Bonds can be retired early through calling them or repurchasing them in the market.
B. Early retirement of bonds will always be at face value as any premium or discount would
have been amortized.
C. Bondholders cannot sell their bonds prior to maturity.
D. When interest rates rise, bond prices also rise.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 6

76. On March 31, 2009, Bundy Corporation retires $10 million of bonds which have an
unamortized premium of $500,000 by repurchasing them in the market for $9,850,000.
Calculate the gain or loss on the retirement of the bonds.
A. $150,000 loss.
B. $150,000 gain.
C. $650,000 gain.
D. $350,000 loss.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 6

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Chapter 010: Reporting and Interpreting Bonds

77. Which of the following statements is true?


A. The corporation will have cash inflow when bonds are issued for an amount equal to,
greater than, or less than the par value of the bonds.
B. The corporation will have to pay cash to bond investors when those investors demand to
call the bonds.
C. The corporation will have an outflow of cash connected to a financing activity when
interest is paid to bond investors.
D. All of these are false.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

78. Which of the following is true?


A. Interest payments reduce cash flow from operating activities.
B. Calling the bonds would reduce cash from investing activities.
C. Issuance of bonds would increase cash from investing activities.
D. All answers are true.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

79. Which of the following is true?


A. An outflow of cash for interest payments is a financing activity.
B. An outflow of cash when convertible bonds are converted is a financing activity.
C. An outflow of cash when callable bonds are recalled by the issuer is a financing activity.
D. None of these answers are true.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

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Chapter 010: Reporting and Interpreting Bonds

80. Which of the following is true?


A. It is common for companies to both retire debt and issue new bonds in the same year as a
way to replace higher interest rate debt with lower rate issuances.
B. Payment of interest is a financing activity since we would not have interest unless we
borrowed money or issued bonds to the public.
C. Repurchasing bonds requires cash outflow connected to investing activities when the
issuing corporation buys back the bonds.
D. None of the other answers are true.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 7

Essay Questions
81. On March 1, 2009, Halbur Corporation, a calendar year company, issued $500,000 of 8%,
five-year bonds at par. The bonds were dated March 1, 2009, and the first annual interest
payment will be on February 28, 2010. The accounting period ends December 31.
Part A. Complete the journal entry grid for each of the following dates (round to the nearest
dollar):

Part B. Discuss why an entry is needed on December 31, 2009.

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Chapter 010: Reporting and Interpreting Bonds


Part A.

Computations:
(a) Issued at par, $500,000
(b) $500,000
8%
10/12 = $33,333
(c) Cash paid: $50,000
8% = $40,000
Interest payable (per b) = $33,333
Interest expense ($500,000
8%
2/12) = $6,667
Part B.
Halbur Corporation has borrowed money via its bonds from March 1 through December 31,
2009. It has, therefore, incurred an expense for the use of money for ten months. To reflect
this interest expense (of $33,333) in the proper accounting period, as accrual adjusting entry is
required.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

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Chapter 010: Reporting and Interpreting Bonds

82. The following information was taken from the income statement of Tommy Toys for the
years 2007 through 2009 (in millions):

A. Compute Tommy Toys times interest earned ratio for all three years:
B. Briefly interpret their times interest earned ratio for the three years.

B. In 2008, Tommy Toys had lower earnings and a higher amount of interest expense
generated in that year. As a result, the ratio reported is lower than in the other two years
examined. However, the ratio was stronger in both 2007 and 2009 indicating sufficient
earnings to cover interest expense on the strength of improved earnings. More important
would be to assess their cash flow from operations to determine if they can pay their interest.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

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Chapter 010: Reporting and Interpreting Bonds

83. The following information is available for Sell-for-Less for the years (in millions).

A. Compute Sell-for-Less's times interest earned ratio for 2009, 2008 and 2007.
B. Briefly interpret their times interest earned ratio for the three years.
A.

B. In the past three years, Sell-for-Less's times interest earned ratio has increased significantly
based primarily on reducing interest expense while increasing net income and reducing
income tax expense.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2

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Chapter 010: Reporting and Interpreting Bonds

84. On January 1, 2009, Clintwood Corporation issued a $1,000, ten-year, 10% bond payable
(interest payable each December 31). For the three assumptions below, complete the
following schedule assuming the accounting year ends December 31, and straight-line
amortization is used:

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2; 3; 4

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Chapter 010: Reporting and Interpreting Bonds


85. On October 1, 2009, Jack Company issued a $5,000, 6%, bond payable. The interest is
payable annually each October 1 and the bond matures in five years. The annual accounting
period for the company ends December 31. Complete the following entries at the date
specified under three different assumptions as to the issue price. Use straight-line amortization

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Chapter 010: Reporting and Interpreting Bonds

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 2; 3; 4

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Chapter 010: Reporting and Interpreting Bonds


86. Ridgetop Company issued the following ten-year bonds payable on January 1, 2009:
$100,000 maturity value, 5% interest payable annually on each December 31. The bonds were
dated January 1, 2009 and the accounting period ends December 31. The bonds were issued at
$98,000.
A. Calculate the following (assume straight-line amortization):
1. Cash inflow at date of issuance
Cash outflow under the 10 year period:
2. Principal
3. Interest
4. Total interest expense
5. Stated interest rate
6. Interest expense for 2010
Balance Sheet at December 31, 2010:
7. Bonds payable
8. Unamortized amount
9. Net book value of bonds
B. Assuming instead that the accounting period ends on June 30, give the adjusting entry
related to interest expense for 2009.

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Chapter 010: Reporting and Interpreting Bonds


A.

B.

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L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

87. On January 1, 2009, Mendez Corporation issued 400 of its $1,000, ten-year, 9% bonds.
The bonds were dated January 1, 2009, and interest is paid annually each December 31. The
bonds issued at 99.
Part A: Give the entry to record the issuance of the bonds on January 1, 2009:
Part B: Were the bonds issued at par, at a premium, or at a discount? How did you arrive at
your answer?
Part A:

Part B:
The bonds were issued at discount. They were issued at 99 which means the bond price equals
to 99% of their face or par value. Since 99 is less than 100%, they were issued at less than par
or at a discount.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

88. Consider the following statement: "Issuing bonds at a discount is bad for the issuing
corporation."Discuss the statement and comment on its validity.
The issuance of bonds at a discount is not bad nor is the issuance of bonds at a premium good.
Bonds are issued at a price based on the market rate of interest. When bonds are issued at a
discount, the market rate exceeds the stated rate. When bonds are issued at a premium, the
stated rate exceeds the market rate. The price at which bonds are issued simply adjusts the
selling price to yield the market rate to the bondholders.

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

89. On January 1, 2009, Schultz Corporation issued $100,000 of its ten-year, 6% bonds
payable at $98,000. The bonds were dated January 1, 2009, and interest is paid each
December 31.
A. Give the entry for the sale of the bonds.
B. Give the entry to record the first interest payment. Assume straight-line amortization.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

90. Houston Company authorized a $1,000,000, 10-year, 6% bond issue dated July 1, 2009,
with annual interest to be paid each December 31. On July 1, 2009, the bonds were issued for
$886,500. Houston Company has a December 31 year-end.
A. Give the entry to record the sale of the bonds.
B. Give the required entry on December 31, 2009 to record amortization (use straight-line.)
C. Was the bond issued at par, at a discount, or at a premium?
D. Will interest expense be greater than or less than the cash payments for interest?

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 3

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Chapter 010: Reporting and Interpreting Bonds

91. On March 1, 2009, Jose, Inc. issued a $1,000, 8%, five-year bond payable for $1,060. The
bond was dated on March 1, 2009, and interest is payable each February 28. Jose, Inc., has a
December 31 year-end.
A. Prepare the entry required on March 1, 2009.
B. Prepare the entry required on December 31, 2009.
C. Prepare the entry required on February 28, 2010.
D. Was the bond issued at par, at a premium, or at a discount?
E. What is the carrying value or book value of the bond on December 31, 2009?
F. Where in the financial statements does the carrying value of the bond appear? (Be specific).
G. On what date does the bond issue mature?

D. Premium
E. $1,050 ($1,000 + 60 10)
F. On the balance sheet in the long-term liabilities section.
G. February 28, 2014 (or March 1, 2014).

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

92. Northridge Company prepared a bond issue dated January 1, 2009. On January 1, 2009,
the company issued $100,000 of its par value bonds $103,000. The bonds mature in thirty
years and have a stated rate of interest of 8% per year. Interest is payable annually on
December 31. Straight-line amortization is used (round to the nearest dollar).
A. Give the entry to record the sale of bonds on January 1, 2009.
B. Give the entry to record interest expense at December 31, 2009 (end of the annual
accounting period)
C. Show how the bonds would be reported on the balance sheet of Northridge Company dated
December 31, 2011

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

93. On January 1, 2009, Lauren Corporation issued $40,000, 9%, ten-year bonds payable at
108. Interest is payable each December 31.
A. Give the entry to record the issuance of the bonds on January 1, 2009.
B. Give the entry to record the first interest payment on December 31, 2009. Use straight-line
amortization.
C. What would the carrying value of the bonds be on December 31, 2010?

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

94. Newton Corporation issued its $1,000,000, 7%, ten-year bonds to the public on January 1,
2009. The bonds pay interest annually, beginning on December 31, 2009. Newton
Corporation received $1,153,420 in cash at the issuance of the bonds. The market rate of
interest when the bonds were issued was 5%. Newton Corporation has a December 31 yearend.
A. Compute the amount of the premium that Newton Corporation should amortize on
December 31, 2009, assuming the "effective-interest" method is used.
B. Compute the amount of the premium that Newton Corporation should amortize on
December 31, 2009, assuming the "straight-line" method is used.
C. Which method above is theoretically the better to use for amortizing a bond premium?
A. ($1,000,000
7% = $70,000)
B. $153,420/10 = $15,342.
C. Effective-interest method.

($1,153,420

5% = $57,671) = $12,329

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

95. Grand Company authorized $150,000 of 5-year bonds dated January 1, 2009. The stated
rate of interest was 14%, payable annually each December 31. The bonds were issued on
January 1, 2009, when the market interest rate was 12%. Assume effective-interest
amortization. (The present value factor for $1 at 6% for 10 periods is 0.5584, for $1 at 7% for
10 periods is 0.5083, for $1 at 14% for 5 periods is 0.5194, and for $1 at 12% for 5 periods is
0.5674. The present value of an annuity of $1 for 10 periods at 6% is 7.3601, for 10 periods at
7% is 7.0236, for 5 periods at 6% is 4.2124, for 5 periods at 7% is 4.1002, and for 5 periods at
12% is 3.6048.) Round to the nearest dollar.
A. What would be the amount of premium amortization for December 31, 2009?
B. What would be the amount of the interest payment on December 31, 2009?
A. $1,703
B. $21,000
Computations:

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 4

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Chapter 010: Reporting and Interpreting Bonds

96. On March 31, 2009 Ridgetop Corp. retired bonds early by repurchasing them in the
market for $9,700,000. The total face value of the bonds retired equaled $10 million and there
is $450,000 of unamortized discount on these bonds. Record the journal entry to retire the
bonds.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 6

97. TreeTop Corporation had issued $5,000,000 of 10-year bonds with a 12% stated rate and
interest to be paid annually. They were issued on January 1, 2004 at 96 and have been
amortized using the straight-line method through December 31, 2010. On June 30, 2011,
TreeTop retired all the bonds by exercising the call feature. The call price was 101. Record
the journal entry for the call of the bonds on June 30, 2011. (Remember to amortize the
discount and update the book value of the bonds for the half-year prior to retirement).

$200,000/10 = $20,000 annual amortization of discount


7.5 years = $150,000 of amortized
discount through June 30, 2011. Face value of the bonds $5,000,000 minus the unamortized
discount $50,000 = book value of $4,950,000 compared to the $5,050,000 cash paid generates
a $100,000 loss.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 6

10-43
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Chapter 010: Reporting and Interpreting Bonds

98. Fence Company reported the following information for 2009 (in millions). Identify where
these items would be classified on the statement of cash flows, (operating, investing, or
financing) and whether they would be added or deducted in those sections.

AACSB Tag: Analytic


Difficulty: Hard
L.O.: 7

99. In a recent year, Tommy Toys reported the following amounts (in millions). Identify
where these items would be classified on the statement of cash flows (operating, investing or
financing)? Also, indicate whether each amount would be added or deducted.

AACSB Tag: Analytic


Difficulty: Medium
L.O.: 7

10-44
2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e

To
Todownload
downloadmore
moreslides,
slides,ebook,
ebook,solutions
solutionsand
andtest
testbank,
bank,visit
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Chapter 010: Reporting and Interpreting Bonds

Matching Questions
100. Match the definitions with the appropriate terms.

1. Callable bonds
2. Bond principal
3. Debenture
4. Stated rate
5. Straight-line amortization
method
6. Effective-interest
amortization method
7. Indenture

The amount payable at the maturity of the


bond.
The theoretically correct approach to
amortizing bond discount or premium.
The rate of cash interest paid per period stated
in the bond contract.
An unsecured bond.
Bonds which may be called for early
retirement at the option of the issuer.
A method which allocates an equal dollar
amount of discount or premium to each interest
period
The bond contract containing legal provisions
relating to the bond.

2
6
4
3
1

5
7

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 1

101. Match the way a bond will sell with the situations given.
1. Bond sells at 93
2. The effective interest rate is greater than the stated rate
3. The stated interest rate equals the effective rate
4. Bond sells at 108
5. The stated interest rate exceeds the effective rate
6. Bond sells at 100

A premium
A discount
Par
A discount
Par
A premium

4
1
6
2
3
5

AACSB Tag: Relative Thinking


Difficulty: Medium
L.O.: 2

10-45
2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e