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Chapter 3
Bonds Payable & Other Concepts
1. The result on the year-end balance sheet of an issue of a 10-year term bond sold at
face amount four years ago with interest payable June 1 and December 1 each year,
is a(an)
a. liability for accrued interest c. increase in deferred charges
b. addition to bonds payable d. contingent liability

2. Unamortized bond discount should be reported on the financial statements of the

issuer as a
a. Direct deduction from the face amount of the bond
b. Direct deduction from the present value of the bond
c. Deferred charge
d. Part of the issue costs

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3. Straight-line amortization of bond premium or discount:

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a. can be used as an optional method of amortization in all situations.

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b. provides the same total amount of interest expense and interest revenue as the

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effective interest method over the life of the bonds.
c. provides the same amounts of interest expense and interest revenue each

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interest period as the effective interest method.
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d. is appropriate when the bond term is especially long.
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e. is appropriate for deep discount bonds.

4. For a bond issue which sells for less than its face amount, the market rate of
interest is
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a. Dependent on the rate stated on the bond.

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b. Equal to rate stated on the bond.

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c. Less than rate stated on the bond.

d. Higher than rate stated on the bond.

5. The market price of a bond issued at a discount is the present value of its principal
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amount at the market (effective) rate of interest

a. Less the present value of all future interest payments at the market (effective)
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rate of interest.
b. Less the present value of all future interest payments at the rate of interest
stated on the bond.
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c. Plus the present value of all future interest payments at the market (effective)
rate of interest.
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d. Plus the present value of all future interest payments at the rate of interest
stated on the bond.

6. Which of the following is not a relevant consideration when evaluating whether to

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derecognize a financial liability?

a. Whether the obligation has been discharged.
b. Whether the obligation has been canceled.
c. Whether the obligation has expired.
d. Whether substantially all the risks and rewards of the obligation have been
transferred.

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7. What is the effective interest rate of a bond or other debt instrument measured at
amortized cost?
a. The stated coupon rate of the debt instrument.
b. The interest rate currently charged by the entity or by others for similar debt
instruments (i.e., similar remaining maturity, cash flow pattern, currency, credit
risk, collateral, and interest basis).
c. The interest rate that exactly discounts estimated future cash payments or
receipts through the expected life of the debt instrument or, when appropriate,
a shorter period to the net carrying amount of the instrument.
d. The basic, risk-free interest rate that is derived from observable government
bond prices.

8. Which of the following statements is false?

a. Bonds carry no corporate ownership privileges.
b. A bond is a financial contract.
c. Bond prices remain fixed over time.
d. A bond issuer must pay periodic interest.

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9. Most bonds:

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a. are money market securities.

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b. are floating-rate securities.

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c. give bondholders a voice in the affairs of the corporation.
d. are interest-bearing obligations of governments or corporations.

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In an “asset swap,” where a liability is settled through the transfer of noncash
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asset,
a. the gain or loss on settlement is computed as the difference between the
carrying amount of the liability extinguished and the fair value of the noncash
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asset transferred.
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b. the gain or loss on settlement is computed as the difference between the

carrying amount of the liability extinguished and the carrying amount of the
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noncash asset transferred.

c. the gain or loss on settlement is computed as the difference between the
carrying amount of the liability extinguished and the more clearly determinable
between the fair value of the liability extinguished and the carrying amount of
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the noncash asset transferred.

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d. no gain or loss is recognized

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“There is a time for everything, and a season for every activity under the heavens;”
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(Ecclesiastes 3:1)

- END –
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1. On January 2, 20x1, Nast Co. issued 8% bonds with a face amount of ₱1,000,000
that mature on January 2, 20x7. The bonds were issued to yield 12%, resulting in a
discount of ₱150,000. Nast incorrectly used the straight-line method instead of the
effective interest method to amortize the discount. How is the carrying amount of
the bonds affected by the error?

At Dec. 31, 20x1 At Jan. 2, 20x7 At Dec. 31, 20x1 At Jan. 2, 20x7

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a. Overstated Understated c. Understated Overstated

b. Overstated No effect d. Understated No effect

2. On July 1, 2003, after recording interest and amortization, York Co. converted
₱1,000,000 of its 12% convertible bonds into 50,000 shares of ₱1 par value
ordinary share. On the conversion date the carrying amount of the bonds was
₱1,300,000, the fair value of the bonds was ₱1,400,000, and York’s ordinary share
was publicly trading at ₱30 per share. What amount of share premium should York
record as a result of the conversion?
a. 950,000 b. 1,250,000 c. 1,350,000 d. 1,500,000

3. On April 30, 20x5, Witt Corp. had outstanding 8%, ₱1,000,000 face amount,
convertible bonds maturing on April 30, 20x9. Interest is payable on April 30 and
October 31. On April 30, 20x5, all these bonds were converted into 40,000 shares
of ₱20 par ordinary share. On the date of conversion:
 Unamortized bond discount was ₱30,000.
 Each bond had a fair value of ₱1,080.
 Each share of stock had a fair value of ₱28.

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What amount should Witt record as a loss on conversion of bonds?

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a. 150,000 b. 110,000 c. 30,000 d. 0

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4. Ray Corp. issued bonds with a face amount of ₱200,000. Each ₱1,000 bond

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contained detachable stock warrants for 100 shares of Ray's common stock. Total
proceeds from the issue amounted to ₱240,000. The fair value of each warrant was
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₱2, and the fair value of the bonds without the warrants was ₱196,000. The bonds
were issued at a discount of
a. 0 b. 678 c. 4,000 d. 33,898
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5. On June 30, 20x9, King Co. had outstanding 9%, ₱5,000,000 face value bonds
maturing on June 30, 2x14. Interest was payable semiannually every June 30 and
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December 31. On June 30, 20x9, after amortization was recorded for the period, the
unamortized bond premium and bond issue costs were ₱30,000 and ₱50,000,
respectively. On that date, King acquired all its outstanding bonds on the open
market at 98 and retired them. At June 30, 20x9, what amount should King
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recognize as gain on redemption of bonds?

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a. 20,000 b. 80,000 c. 120,000 d. 180,000

6. On July 31, 20x0, Dome Co. issued ₱1,000,000 of 10%, 15-year bonds at par and
used a portion of the proceeds to call its 600 outstanding 11%, ₱1,000 face value
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bonds, due on July 31, 2x10, at 102. On that date, unamortized bond premium
relating to the 11% bonds was ₱65,000. In its 20x0 income statement, what amount
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should Dome report as gain or loss, before income taxes, from retirement of bonds?
a. 53,000 gain b. 0 c. (65,000) loss d. (77,000) loss

7. During 20x4 Peterson Company experienced financial difficulties and is likely to

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default on a ₱500,000, 15%, three-year note dated January 1, 20X2, payable to

Forest National Bank. On December 31, 20X4, the bank agreed to settle the note
and unpaid interest of ₱75,000 for 20X4 for ₱50,000 cash and marketable
securities having a carrying amount of ₱375,000. Peterson's acquisition cost of the
securities is ₱385,000. What amount should Peterson report as a gain from the debt
restructuring in its 20x4 income statement?
a. 65,000 b. 75,000 c. 140,000 d. 150,000

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8. Casey Corporation entered into a troubled-debt restructuring agreement with First

State Bank. First State agreed to accept land with a carrying amount of ₱85,000
and a fair value of ₱120,000 in exchange for a note with a carrying amount of
₱185,000. What amount should Casey report as gain in its income statement?
a. 0 b. 35,000 c. 65,000 d. 100,000

9. Wood Corp., a debtor undergoing financial difficulties granted an equity interest to

a creditor in full settlement of a ₱28,000 debt owed to the creditor. At the date of
this transaction, the equity interest had a fair value of ₱25,000 and par value of
₱20,000. What amount should Wood recognize as gain on restructuring of debt?
a. 0 b. 3,000 c. 5,000 d. 8,000

10. In 20X2, May Corp. acquired land by paying ₱75,000 down and signing a note with
a maturity value of ₱1,000,000. On the note’s due date, December 31, 20X7, May
owed ₱40,000 of accrued interest and ₱1,000,000 principal on the note. May was in
financial difficulty and was unable to make any payments. May and the bank agreed
to amend the note as follows:

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 The ₱40,000 of interest due on December 31, 20X7, was forgiven.

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 The principal of the note was reduced from ₱1,000,000 to ₱950,000 and the

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maturity date extended 1 year to December 31, 20X8.

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 May would be required to make one interest payment totaling ₱30,000 on
December 31, 20X8.

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 The original effective interest rate is 10% while the current market rate on
December 31, 20X7 is 12%.
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As a result of the troubled debt restructuring, May should report a gain, before taxes,
in its 20X7 income statement of
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a. 0 b. 165,000 c. 60,000 d. 149,092

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“Blessed are the pure in heart, for they will see God.” (Matthew 5:8)
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SOLUTIONS
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1. B
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Solution:
EFFECT ON DECEMBER 31, 20X1:
Using straight line method:
Discount on bonds - 1/2/x1 150,000
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Divide by: Term 6

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Annual amortization of discount 25,000

Discount on bonds - 1/2/x1 150,000

Amortization - 20x1 (25,000)
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Discount on bonds - 12/31/x1 125,000

Face amount 1,000,000

Discount on bonds - 12/31/x1 (125,000)
Carrying amount - 12/31/x1 875,000

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Using effective interest method:

Date Interest expense Payments Amortization Present Value
1/2/x1 850,000
12/31/x1 102,000 80,000 22,000 872,000

Carrying amounts - 12/31/x1:

Straight line (erroneous) 875,000
Effective interest method 872,000

Difference - overstatement (3,000)

EFFECT ON JANUARY 2, 20X7:

On January 2, 20x7, maturity date, there will be NO EFFECT of the error on the carrying amount of the
bonds because on this date, the discount would have been fully amortized under both the straight line
method and the effective interest method.

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2. B

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Solution:

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Carrying amount of bonds converted 1,300,000

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Par value of shares issued (50,000 x 1) (50,000)
Share premium 1,250,000

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3. D – No gain or loss is recognized when convertible bonds are converted into equity instrument.
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4. C
Solution:
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Fair value of bonds without the warrants 196,000

Face amount of bonds 200,000
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Discount on bonds (4,000)

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5. B
Solution:
Redemption price (5M x 98%) 4,900,000
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Less: Carrying amount of bonds:

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Face amount 5,000,000

Unamortized premium 30,000
Unamortized issue costs (50,000) 4,980,000
Gain on retirement 80,000
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6. A
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Solution:
Redemption price (600 x 1,000 x 102%) 612,000
Less: Carrying amount of bonds:
Face amount (600 x 1,000) 600,000
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Unamortized premium 65,000 665,000

Gain on retirement 53,000

7. D
Solution:
Payment for the liability:

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Cash 50,000
Carrying amount of investment securities 375,000 425,000
Carrying amount of liability settled:
Principal 500,000
Accrued interest 75,000 575,000
Gain on settlement 150,000

8. D (185,000 carrying amt. of note - 85,000 carrying amt. of land) = 100,000 gain

9. B (28,000 – 25,000) = 3,000

10. D
Solution:
The modification is analyzed as follows:
Old terms New terms
Principal 1,000,000 950,000
Accrued interest 40,000 30,000
Remaining term ('n') 1 year

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The present value of the modified liability is computed as follows:

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Present
Future cash flows PV of 1 @10%, n=1

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value
Principal 950,000 0.90909 863,636

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Interest 30,000 0.90909 27,273
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Present value of the modified liability 890,908
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The difference between the old liability and the new liability is tested for substantiality.
Carrying amount of old liability
1,040,000
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(1M principal + 40,000 accrued interest)

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Present value of modified liability 890,908

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Difference 149,092
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Difference 149,092
Divide by: Carrying amount of old liability 1,040,000
14.34%

The modification is considered substantial because the modification resulted to a present value of the
new obligation different by at least 10% of the present value (carrying amount) of old obligation.
Therefore, the old liability is extinguished and the difference of ₱149,092 is recognized as gain on
extinguishment.

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