TBchap 010

Chapter 10
Bonds and Long-Term Notes
True / False Questions
1. Periodic interest expense is the stated interest rate times the amount of debt outstanding
during the period.
True False
2. The carrying value of zero coupon bonds increases by the periodic amount of interest
recognized.
True False
3. Bonds will sell for a premium when the market rate of interest exceeds their stated rate.
True False
4. The initial selling price of bonds represents the sum of all the future cash outflows required by
the obligation.
True False
5. Amortization of discount on bonds payable results in interest expense that is less than the
actual cash outflow.
True False
10-1
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6. Premium on bonds payable is a contra liability account.
True False
7. Transaction costs of issuing debt securities are expensed to the income statement when they
are incurred.
True False
8. Equity is increased when bonds payable are issued with a conversion feature.
True False
9. The difference between the fair value of a financial liability and consideration paid in cash or
through transfer of noncash assets or assumption of liabilities is recognized in profit or loss.
True False
10. If a company chooses the option to report its bonds at fair value, then it reports changes in
fair value in its income statement unless the changes are attributable to changes in own
credit risk.
True False
Multiple Choice Questions
10-2
11. Interest expense is ______.
A. the effective interest rate times the amount of the debt outstanding during the interest
period
B. the stated interest rate times the amount of the debt outstanding during the interest
period
C. the effective interest rate times the principal amount of the debt
D. the stated interest rate times the principal amount of the debt
10-3
12. Lopez Plastics Co. (LPC) issued callable bonds on January 1, 2018. LPC's accountant has
projected the following amortization schedule from issuance until maturity:
Date Cash Interest Effective Interest Decrease in Balance Outstanding Balance
January 1, 2018 $207,020
June 30, 2018 $7,000 $6,211 $789 206,230
December 31, 7,000 6,187 813 205,417

2018
June 30, 2019 7,000 6,163 837 204,580
December 31, 7,000 6,137 863 203,717

2019
June 30, 2020 7,000 6,112 888 202,829
December 31, 7,000 6,085 915 201,913

2020
June 30, 2021 7,000 6,057 943 200,971
December 31, 7,000 6,029 971 200,000

2021
What is the annual stated interest rate on the bonds?
A. 3.5%
B. 6%
C. 7%
D. none of these
10-4
13. A $500,000 bond issue sold at 98. Therefore, the bonds ______.
A. sold at a discount because the stated rate of interest was lower than the effective rate
B. sold for the $500,000 face amount less $10,000 of accrued interest
C. sold at a premium because the stated rate of interest was higher than the yield rate
D. sold at a discount because the effective interest rate was lower than the face rate
14. When bonds are sold at a discount and the effective interest method is used, at each
subsequent interest payment date, the cash paid is ______.
A. more than the effective interest
B. less than the effective interest
C. equal to the effective interest
D. more than if the bonds had been sold at a premium
15. When bonds are sold at a premium and the effective interest method is used, at each interest
payment date, the interest expense ______.
A. remains constant
B. is equal to the change in book value
C. increases
D. decreases
10-5
16. Bonds were issued at a discount. In the bond amortization schedule, ______.
A. the interest expense is less with each successive interest payment
B. the total effective interest over the term to maturity is equal to the amount of the discount
plus the total cash interest paid
C. the outstanding balance (book value) of the bonds declines eventually to face value
D. the reduction in the discount is less with each successive interest payment
17. On January 1, 2018, Legion Company sold $200,000 of 10% ten-year bonds. Interest is
payable semiannually on June 30 and December 31. The bonds were sold for $177,000, priced
to yield 12%. Legion records interest at the effective rate.
Legion should report bond interest expense for the six months ended June 30, 2018 in the
amount of ______.
A. $8,850
B. $10,000
C. $10,620
D. $12,000
18. A bond issue with a principal amount of $500,000 bears interest at the rate of 10%. The
current market rate of interest is 11%. These bonds will sell at a price that is ______.
A. equal to $500,000
B. more than $500,000
C. less than $500,000
D. the answer cannot be determined from the information provided
10-6
19. A bond is issued with a principal amount of $500,000 and a stated interest rate of 10%. The
20. Zero coupon bonds ______.
A. offer a return in the form of a deep discount off the face value
B. result in zero interest expense for the issuer
C. result in zero interest revenue for the investor
D. are reported as shareholders' equity by the issuer
10-7
21. Discount-Mart issued 10,000 $1,000 bonds on January 1, 2018. The bonds have a ten-year
term and pay interest semiannually. This is the partial bond amortization schedule for the
bonds.
Payment Cash Effective Interest Decrease in Balance Outstanding Balance
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What is the stated annual rate of interest on the bonds?
A. 3%
B. 4%
C. 6%
D. 8%
10-8
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What is the effective annual rate of interest on the bonds?
A. 3%
B. 4%
C. 6%
D. 8%
10-9
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What is the interest expense on the bonds for the year ended December 31, 2019?
A. $700,700
B. $600,000
C. $347,464
D. $100,700
10-10
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What is the book value of the bonds as of December 31, 2019?
A. $8,834,770
B. $8,686,606
C. $8,734,070
D. $8,783,433
10-11
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What would be the total interest cost of the bonds over their full term?
A. $1,359,033
B. $4,640,967
C. $6,000,000
D. $7,359,033
10-12
26. Prescott Corporation issued 10,000 $1,000 bonds on January 1, 2018. The bonds have a ten-
year term and pay interest semiannually. This is the partial bond amortization schedule for
the bonds.
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
A. 3%
B. 4%
C. 6%
D. 8%
10-13
the bonds.
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
What is the interest expense on the bonds in 2019?
A. $800,000
B. $680,759
C. $342,971
D. $119,241
10-14
the bonds.
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
A. $11,432,379
B. $11,375,350
C. $11,316,611
D. $11,256,109
10-15
the bonds.
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
What would be the total interest expense recognized for the bond issue over its full term?
A. $6,512,253
B. $8,000,000
C. $9,487,747
D. $11,487,747
30. When a long-term note is given in exchange for equipment, the amount considered as paid
for the machine is ______.
A. the invoice price
B. the wholesale price
C. the present value of cash outflows discounted at the stated rate
D. the present value of the note payments discounted at the market rate
10-16
31. Green Industries purchased a machine from Cyan Corporation on October 1, 2018. In payment
for the $144,000 purchase, Green issued a one-year installment note to be paid in equal
monthly payments at the end of each month. The payments include interest at the rate of
12%. Monthly installment payments are closest to ______.
A. $12,000
B. $12,445
C. $12,668
D. $12,794
32. Magenta Company purchased a machine from Pink Corporation on October 31, 2018. In
payment for the $288,000 purchase, Magenta issued a one-year installment note to be paid in
equal monthly payments of $25,588 at the end of each month. The payments include interest
at the rate of 12%. The amount of interest expense that Magenta will report in its income
statement for the year ended December 31, 2018 is ______.
A. $2,559
B. $2,880
C. $5,533
D. $5,760
33. On February 1, 2017, Pat Weaver Inc. (PWI) issued 10%, $1,000,000 bonds for $1,116,000. PWI
retired all of these bonds on January 1, 2018 at 102. Unamortized bond premium on that date
was $92,800. How much gain or loss should be recognized on this bond retirement?
A. $0 gain
B. $111,800 gain
C. $72,800 gain
D. $96,000 gain
10-17
34. Rick's Pawn Shop issued 11% bonds, dated January 1, with a face amount of $400,000 on
January 1, 2019. The bonds sold for $370,000. For bonds of similar risk and maturity, the
market yield was 12%. Interest is paid semiannually on June 30 and December 31. Rick's
determines interest at the effective rate and elected the option to report these bonds at their
fair value. On December 31, 2019, the fair value of the bonds was $365,000, with $2,000 of the
change due to a change in general interest rates. Rick's other comprehensive income will
include ______.
A. an unrealized gain from change in the fair value of debt of $5,412
B. an unrealized loss from change in the fair value of debt of $3,412
C. an unrealized gain from change in the fair value of debt of $2,000
D. an unrealized gain from change in the fair value of debt of $3,412
35. On January 1, 2023, Ozark Minerals issued $20 million of 9%, ten-year convertible bonds at
101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible
into forty shares of Ozark's no par ordinary shares. Bonds that are similar in all respects,
except that they are nonconvertible, currently are selling at 99. Upon issuance, Ozark should
______.
A. credit bonds payable $20,000,000 and discount on bonds payable $200,000
B. credit bonds payable $20,000,000 and premium on bonds payable $200,000
C. credit bonds payable $20,000,000 and equity $200,000
D. credit bonds payable $20,200,000
10-18
36. On December 15, 2023, Lin Corporation had on its books a carrying amount of $456,000 of
convertible bonds and the carrying amount of $100,000 of equity options in shareholders'
equity. Both of these items relate to convertible bonds issued in 2015. The principal amount
of the bonds remaining on that date was $500,000. Each $1,000 bond is convertible into forty
shares of Lin's no-par ordinary shares. Thirty percent of the bonds were converted on
December 16, 2023. The market price of Lin's share was $11 on that date. Lin should ______.
A. credit share capital $163,200
B. credit share capital $220,000
C. credit share capital $166,800
D. credit share capital $136,800
Matching Questions
37. Listed below are four terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the most correct term.
The amount by which the reacquisition

1. Stock warrant price of debt exceeds book value. ____
2. Fair value option Protects the debt issuer if rates fall. ____
3. Loss on Gain or loss from own credit risk
extinguishment reported in other comprehensive income. ____
Right of an investor to purchase a
4. Call feature specific number of shares at a fixed price. ____
10-19
38. Listed below are four terms followed by a list of phrases that describe or characterize each of
1. Times interest earned Measures ability to service

ratio debt. ____
2. Debt to equity ratio Measures default risk. ____
3. Zero coupon bonds Bought at a deep discount. ____
4. Convertible bonds May become equity shares. ____
39. Listed below are five terms followed by a list of phrases that describe or characterize each of
1. Discount on bonds Market rate less than stated rate. ____

2. Installment notes Market rate higher than stated rate. ____
3. Premium on bonds Many separate maturity dates. ____
4. Serial bonds No maturity payment. ____
5. Debt issue costs Legal, accounting, printing. ____
40. Listed below are five terms followed by a list of phrases that describe or characterize each of
the terms. Match each phrase with the correct term.
1. Straight-line Additional consideration is recorded as

method an expense. ____
2. Warrants No gain or loss recorded. ____
3. Zero coupon Often traded separately from
bonds associated bonds. ____
4. Induced Requires(s) no cash outflow before
conversion maturity. ____
5. Conversion of A practical expediency in US GAAP but
bonds not in IFRS. ____
10-20
41.
Listed below are several terms and phrases associated with long-term debt. Match each
phrase with the most correct term.
1. Market rate higher than stated

rate Straight-line method ____
2. Debt issue costs May become stock ____
3. Mortgage bond Bond price ____
Protection against
4. Convertible bonds falling rates ____
Legal, accounting,
5. Subordinated debenture printing ____
6. Balance times effective rate Discount ____
Name of owner not
7. Registered bonds registered ____
8. Call feature Bond indenture ____
9. Calculation of interest expense
permitted under US GAAP but not
IFRS Premium ____
10. Present value of interest plus
present value of principal Periodic cash payments ____
Checks are mailed
11. Coupon bonds directly ____
No specific assets
12. Debenture bond pledged ____
13. Stated rate higher than market
rate Backed by a lien ____
14. Principal amount times stated
rate Interest expense ____
Liquidation payments
15. Promises made to bondholders after other claims satisfied ____
10-21
Short Answer Questions
42. On January 1, 2018, Morton Sales Co. issued zero coupon bonds with a face value of $6 million
for cash. The bonds mature in ten years and were issued at a price of $3,050,100.
Required: How much interest will Morton Sales Co. pay on these bonds in 2018?
Required: What was the annual effective interest rate in the market when the bonds were
issued?
10-22
Required: What amount of interest expense on these bonds would Morton Sales Co. report in
its 2018 income statement?
Required: What will Morton Sales Co. report on these bonds in its December 31, 2018 balance
sheet?
10-23
Required: What total interest expense will Morton Sales Co. report over the ten-year life of
these bonds?
10-24
Determine the price of a $500,000 bond issue under each of the following independent
assumptions:
Maturity Interest Paid Stated Rate Effective Rate
1. Ten years Annually 10% 12%
2. Ten years Semiannually 10% 12%
3. Twenty years Semiannually 12% 10%
10-25
48. On January 1, 2018, Bishop Company issued 10% bonds dated January 1, 2018, with a face
amount of $20 million. The bonds mature in 2027 (ten years). For bonds of similar risk and
maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December 31.
Required:
1. Determine the price of the bonds on January 1, 2018.

2. Prepare the journal entry to record the bond issuance by Bishop on January 1, 2018.
3. Prepare the journal entry to record interest on June 30, 2018, using the effective interest
method.
4. Prepare the journal entry to record interest on December 31, 2018, using the effective
interest method.
10-26
49. On January 1, 2018, Mania Enterprises issued 12% bonds dated January 1, 2018, with a face
maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December 31.
Required:

2. Prepare the journal entry to record the bond issuance by Mania on January 1, 2018.
method.
interest method.
10-27
50. Miranda Company contracted with Stewart Corporation to construct custom-made
equipment. The equipment was completed and ready for use on January 1, 2018. Miranda
paid for the machine by issuing a $200,000, three-year note that bears interest at the rate of
4%, payable annually on December 31 each year. Since the machine was custom-built, the
cash price was unknown. However, when compared to similar contracts, 10% was deemed to
be a reasonable rate of interest.
Required:
1. Prepare the journal entry by Miranda to record the purchase of equipment.

2. Prepare journal entries to record interest for each of the first two years.
10-28
51. In its 2018 annual report to shareholders, Health Foods, Inc. disclosed the following
information about some of its indebtedness:
The fair value of convertible subordinated debentures is estimated using quoted market
prices. Book amounts and estimated fair values of our financial instruments other than those
for which book amounts approximate fair values as noted above are as follows (in thousands)
2018 2017
Book Amount Estimated Book Amount Estimated

Fair Value Fair Value
Convertible subordinated debentures $ 158,791 $295,923 $151,449 $200,396
In addition, the company disclosed the following:
We have outstanding zero coupon convertible subordinated debentures which had a book
amount of approximately $158.8 million and $151.4 million on September 26, 2018, and
September 28, 2017, respectively. The debentures have an effective yield to maturity of 5
percent and a principal amount at maturity on March 2, 2032 of approximately $308.8 million.
The debentures are convertible at the option of the holder, at any time on or prior to
maturity, unless previously redeemed or otherwise purchased. The debentures have a
conversion rate of 10.64 shares per $1,000 principal amount at maturity, representing
3,285,632 shares. The debentures may be redeemed at the option of the holder on March 2,
2022 or March 2, 2027, at the issue price plus accrued original discount totaling
approximately $188 million and $241 million, respectively.
Required: Explain why the estimated fair value of the debentures exceeds their book amount
at the end of fiscal year 2018.
10-29
2018 2017

Required: Why did the book amount of the debentures increase during fiscal year 2018?
10-30
2018 2017

Required: What amount of interest expense will Health Foods accrue on the debentures
during fiscal year 2019?
10-31
2018 2017
Book Amount Estimated Fair Book Amount Estimated Fair

Value Value
Required: Determine the gain or loss that Health Foods would have reported in its 2018
income statement if it had redeemed (and retired) the debentures at fair value at the end of
the fiscal year.
10-32
55. On January 1, 2023, Comet Products issued $40 million of 6%, ten-year convertible bonds at a
net price of $40.8 million. The effective interest rate on the bond is 6.1352734%. Comet
recently issued similar, but nonconvertible, bonds at 99 (i.e., 99% of face amount). The bonds
pay interest on June 30 and December 31. Each $1,000 bond is convertible into thirty shares
of Comet's no-par ordinary shares.
On June 1, 2025, Comet notified bondholders of its intent to call the bonds at face value plus a
1% call premium on July 1, 2025. By June 30, all bondholders had chosen to convert their
bonds into shares as of the interestpayment date. On June 30, Comet paid the semiannual
interest and issued the requisite number of shares for the bonds being converted.
Required:
1. Prepare the journal entry for the issuance of the bonds by Comet.
2. Prepare the journal entry for the June 30, 2023 interest payment.
3. Prepare the journal entries for the June 30, 2025 interest payment by Comet and the
conversion of the bonds (book value method).
4. Explain the difference in the accounting for convertible debt in US GAAP as compared to
the IFRS.
5. If Comet applies US GAAP in the preparation of its financial statements, how would the
journal entry in (1) and (2) differ?
Workings:
The fair value of the bond without the conversion option = 99% ×$40 million = $39.6 million
The unamortized discount at issue date = Principal (face) amount less the fair value of the
bond without the conversion option = $40 million - $39.6 million = $400,000
The amortization table for the bond from January 1, 2023 to June 30, 2025 is as follows:
Date Interest Payable Interest Expense Unamortized Discount Carrying Amount
January 1, $400,000.00 $39,600,000.00

2023
June 30, 2023 $1,200,000.00 $1,214,784.13 $385,215.87 $39,614,784.13
10-33
December 31, $1,200,000.00 $1,215,237.66 $369,978.21 $39,630,021.79
2023
June 30, 2024 $1,200,000.00 $1,215,705.09 $354,273.12 $39,645,726.88
December 31, $1,200,000.00 $1,216,186.87 $338,086.25 $39,661,913.75

2024
June 30, 2025 $1,200,000.00 $1,216,683.42 $321,402.83 $39,678,597.17
56. Tru Fashions has bonds outstanding during a year in which the market rate of interest has
declined. If Tru has elected the fair value option for the bonds, will it report a gain or a loss on
the bonds for the year? Explain.
10-34
57. Heidi Baby Products issued 8% bonds with a face amount of $320 million on January 1, 2018.
The bonds sold for $300 million. For bonds of similar risk and maturity, the market yield was
9%. Upon issuance, Heidi elected the option to report these bonds at their fair value. On June
30, 2018, the fair value of the bonds was $310 million as determined by their market value on
the NASDAQ. Will Heidi report a gain or will it report a loss when adjusting the bonds to fair
value? If the change in fair value is attributable to a change in the general (risk-free) interest
rate, did the rate increase or decrease? If the change in fair value is attributable to a change in
the general (risk-free) interest rate, is the gain or loss reported as part of net income? Explain.
10-35
Chapter 10 Bonds and Long-Term Notes Answer Key
True / False Questions
1. Periodic interest expense is the stated interest rate times the amount of debt outstanding
during the period.
FALSE
AACSB: Reflective Thinking

AICPA:
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-02 Account for bonds issued at par, at a discount, or at a premium, recording interest using the
effective interest method.
Topic: Determining interest and amortization
2. The carrying value of zero coupon bonds increases by the periodic amount of interest
recognized.
TRUE

AICPA:
Blooms: Remember
Difficulty: 1 Easy
Topic: Zero coupon bonds
10-36
3. Bonds will sell for a premium when the market rate of interest exceeds their stated rate.
FALSE

AICPA:
Blooms: Remember
Difficulty: 1 Easy
Topic: Determining the selling price of bonds
4. The initial selling price of bonds represents the sum of all the future cash outflows required
by the obligation.
FALSE

AICPA:
Blooms: Understand
Difficulty: 2 Medium
5. Amortization of discount on bonds payable results in interest expense that is less than the
actual cash outflow.
FALSE
AACSB: Analytical Thinking

AICPA:
Blooms: Analyze
10-37
6. Premium on bonds payable is a contra liability account.
FALSE

AICPA:
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-05 Describe the disclosures appropriate to long-term debt in its various forms and calculate related
financial ratios.
Topic: Bonds at issuance
Topic: Financial statement disclosures
7. Transaction costs of issuing debt securities are expensed to the income statement when
they are incurred.
FALSE

AICPA:
Blooms: Remember
Learning Objective: 10-04 Characterize the accounting treatment of notes and bonds, issued for cash or for noncash
consideration.
Topic: Long-term notes
8. Equity is increased when bonds payable are issued with a conversion feature.
TRUE

AICPA:
10-38
Blooms: Remember
Learning Objective: 10-06 Record the early extinguishment of debt and its conversion into equity securities.
Topic: Convertible Bonds
9. The difference between the fair value of a financial liability and consideration paid in cash
or through transfer of noncash assets or assumption of liabilities is recognized in profit or
loss.
FALSE

AICPA:
Blooms: Remember
10. If a company chooses the option to report its bonds at fair value, then it reports changes in
fair value in its income statement unless the changes are attributable to changes in own
credit risk.
TRUE

AICPA:
Blooms: Remember
Learning Objective: 10-03 Understand the option to report liabilities at their fair values.
Topic: Option to report liabilities at fair value
Multiple Choice Questions
10-39
11. Interest expense is ______.
A. the effective interest rate times the amount of the debt outstanding during the interest
period
B. the stated interest rate times the amount of the debt outstanding during the interest
period
C. the effective interest rate times the principal amount of the debt
D. the stated interest rate times the principal amount of the debt

AICPA:
Blooms: Remember
Difficulty: 1 Easy
10-40
12. Lopez Plastics Co. (LPC) issued callable bonds on January 1, 2018. LPC's accountant has
projected the following amortization schedule from issuance until maturity:
Date Cash Interest Effective Interest Decrease in Balance Outstanding

Balance
January 1, 2018 $207,020
June 30, 2018 $7,000 $6,211 $789 206,230
December 31, 7,000 6,187 813 205,417

2018
June 30, 2019 7,000 6,163 837 204,580
December 31, 7,000 6,137 863 203,717

2019
June 30, 2020 7,000 6,112 888 202,829
December 31, 7,000 6,085 915 201,913

2020
June 30, 2021 7,000 6,057 943 200,971
December 31, 7,000 6,029 971 200,000

2021
What is the annual stated interest rate on the bonds?
A. 3.5%
B. 6%
C. 7%
D. none of these
This is the annual cash interest paid ($14,000), divided by the maturity (face) value of
$200,000.

AICPA:
10-41
Blooms: Analyze
13. A $500,000 bond issue sold at 98. Therefore, the bonds ______.
A. sold at a discount because the stated rate of interest was lower than the effective rate
B. sold for the $500,000 face amount less $10,000 of accrued interest
C. sold at a premium because the stated rate of interest was higher than the yield rate
D. sold at a discount because the effective interest rate was lower than the face rate

AICPA:
Blooms: Analyze
14. When bonds are sold at a discount and the effective interest method is used, at each
subsequent interest payment date, the cash paid is ______.
A. more than the effective interest
B. less than the effective interest
C. equal to the effective interest
D. more than if the bonds had been sold at a premium

AICPA:
Blooms: Analyze
10-42
Topic: Effective interest method-Discount
15. When bonds are sold at a premium and the effective interest method is used, at each
interest payment date, the interest expense ______.
A. remains constant
B. is equal to the change in book value
C. increases
D. decreases

AICPA:
Blooms: Analyze
Topic: Effective interest method-Premium
16. Bonds were issued at a discount. In the bond amortization schedule, ______.
A. the interest expense is less with each successive interest payment
B. the total effective interest over the term to maturity is equal to the amount of the
discount plus the total cash interest paid
C. the outstanding balance (book value) of the bonds declines eventually to face value
D. the reduction in the discount is less with each successive interest payment

AICPA:
Blooms: Analyze
10-43
17. On January 1, 2018, Legion Company sold $200,000 of 10% ten-year bonds. Interest is
payable semiannually on June 30 and December 31. The bonds were sold for $177,000,
priced to yield 12%. Legion records interest at the effective rate.
Legion should report bond interest expense for the six months ended June 30, 2018 in the
amount of ______.
A. $8,850
B. $10,000
C. $10,620
D. $12,000
6% × $177,000 = $10,620.
AACSB: Knowledge Application

AICPA:
Blooms: Apply
10-44
18. A bond issue with a principal amount of $500,000 bears interest at the rate of 10%. The

When the market rate of interest is higher than the bonds' stated rate, the bonds will sell at
a discount.

AICPA:
Blooms: Analyze
19. A bond is issued with a principal amount of $500,000 and a stated interest rate of 10%. The

When the market rate of interest is lower than the bonds' stated rate, the bonds will sell at
a premium.
10-45
AICPA:
Blooms: Analyze
20. Zero coupon bonds ______.
A. offer a return in the form of a deep discount off the face value
B. result in zero interest expense for the issuer
C. result in zero interest revenue for the investor
D. are reported as shareholders' equity by the issuer

AICPA:
Blooms: Understand
10-46
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What is the stated annual rate of interest on the bonds?
A. 3%
B. 4%
C. 6%
D. 8%
($300,000/$10,000,000) × 2 = 6%.

AICPA:
Blooms: Analyze
10-47
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
A. 3%
B. 4%
C. 6%
D. 8%
($345,639/$8,640,967) × 2 = 8%.

AICPA:
Blooms: Analyze
10-48
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What is the interest expense on the bonds for the year ended December 31, 2019?
A. $700,700
B. $600,000
C. $347,464
D. $100,700
Semiannual effective rate = $345,639/$8,640,967 = 4%
Interest expense = $349,363 + ($8,783,433 × 4%) = $700,700.

AICPA:
Blooms: Apply
Difficulty: 3 Hard
10-49
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
A. $8,834,770
B. $8,686,606
C. $8,734,070
D. $8,783,433
Amortization Payment 4 = ($8,783,433 × 4%) − $300,000 = $51,337
Book value = $8,783,433 + $51,337 = $8,834,770.

AICPA:
Blooms: Apply
Difficulty: 3 Hard
consideration.
10-50
bonds.
1 300,000 345,639 45,639 8,640,967
2 300,000 347,464 47,464 8,686,606
3 300,000 349,363 49,363 8,734,070
4 300,000 8,783,433
What would be the total interest cost of the bonds over their full term?
A. $1,359,033
B. $4,640,967
C. $6,000,000
D. $7,359,033
($300,000 × 2 × 10) + ($10,000,000 − $8,640,967) = $7,359,033.

AICPA:
Blooms: Analyze
Difficulty: 3 Hard
10-51
26. Prescott Corporation issued 10,000 $1,000 bonds on January 1, 2018. The bonds have a
ten-year term and pay interest semiannually. This is the partial bond amortization
schedule for the bonds.
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
A. 3%
B. 4%
C. 6%
D. 8%
($344,632/$11,487,747) × 2 = 6%.

AICPA:
Blooms: Analyze
10-52
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
What is the interest expense on the bonds in 2019?
A. $800,000
B. $680,759
C. $342,971
D. $119,241
Interest expense = $341,261 + ($11,316,611 × 3%) = $680,759.

AICPA:
Blooms: Apply
Difficulty: 3 Hard
10-53
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
A. $11,432,379
B. $11,375,350
C. $11,316,611
D. $11,256,109
Amortization Payment 4 = $400,000– ($11,316,611 × 3%) = $60,502
Book value = $11,316,611– $60,502 $11,256,109

AICPA:
Blooms: Apply
Difficulty: 3 Hard
consideration.
10-54
1 400,000 344,632 55,368 11,487,747
2 400,000 342,971 57,029 11,432,379
3 400,000 341,261 58,739 11,375,350
4 400,000 11,316,611
What would be the total interest expense recognized for the bond issue over its full term?
A. $6,512,253
B. $8,000,000
C. $9,487,747
D. $11,487,747
($400,000 × 2 × 10) − ($11,487,747 − 10,000,000) = $6,512,253.

AICPA:
Blooms: Analyze
Difficulty: 3 Hard
10-55
30. When a long-term note is given in exchange for equipment, the amount considered as paid
for the machine is ______.
A. the invoice price
B. the wholesale price
C. the present value of cash outflows discounted at the stated rate
D. the present value of the note payments discounted at the market rate

AICPA:
Blooms: Remember
Difficulty: 1 Easy
Topic: Note exchanged for assets
31. Green Industries purchased a machine from Cyan Corporation on October 1, 2018. In
payment for the $144,000 purchase, Green issued a one-year installment note to be paid in
equal monthly payments at the end of each month. The payments include interest at the
rate of 12%. Monthly installment payments are closest to ______.
A. $12,000
B. $12,445
C. $12,668
D. $12,794
Calculation of installment payment:
$144,000 ÷ 11.25508 = $12,794

amount (PV of annuity) installment
of loan n = 12, i = 1% payment

AICPA:
Blooms: Apply
10-56
Difficulty: 3 Hard
consideration.
Topic: Installment notes
32. Magenta Company purchased a machine from Pink Corporation on October 31, 2018. In
payment for the $288,000 purchase, Magenta issued a one-year installment note to be
paid in equal monthly payments of $25,588 at the end of each month. The payments
include interest at the rate of 12%. The amount of interest expense that Magenta will
report in its income statement for the year ended December 31, 2018 is ______.
A. $2,559
B. $2,880
C. $5,533
D. $5,760
November 30, 2018
Interest expense (1% × outstanding balance) 2,880
Note payable (difference) 22,708
Cash (payment determined below) 25,588
December 31, 2018
Interest expense (1% × [$288,000 − 22,708]) 2,653
Note payable (difference) 22,935
Cash (payment determined above) 25,588
November (1% × $288,000) $2,880
December (1% × [$288,000 − 22,708]) 2,653
2018 interest expense $5,533

AICPA:
Blooms: Apply
Difficulty: 3 Hard
10-57
consideration.
Topic: Installment notes
33. On February 1, 2017, Pat Weaver Inc. (PWI) issued 10%, $1,000,000 bonds for $1,116,000.
PWI retired all of these bonds on January 1, 2018 at 102. Unamortized bond premium on
that date was $92,800. How much gain or loss should be recognized on this bond
retirement?
A. $0 gain
B. $111,800 gain
C. $72,800 gain
D. $96,000 gain
Paid at redemption: $1,000,000 × 102% = $1,020,000
Book value: $1,000,000 + $92,800 1,092,800
Gain on bond retirement $72,800

AICPA:
Blooms: Apply
Topic: Early extinguishment of debt
10-58
34. Rick's Pawn Shop issued 11% bonds, dated January 1, with a face amount of $400,000 on
January 1, 2019. The bonds sold for $370,000. For bonds of similar risk and maturity, the
market yield was 12%. Interest is paid semiannually on June 30 and December 31. Rick's
determines interest at the effective rate and elected the option to report these bonds at
their fair value. On December 31, 2019, the fair value of the bonds was $365,000, with
$2,000 of the change due to a change in general interest rates. Rick's other comprehensive
income will include ______.
A. an unrealized gain from change in the fair value of debt of $5,412
B. an unrealized loss from change in the fair value of debt of $3,412
C. an unrealized gain from change in the fair value of debt of $2,000
D. an unrealized gain from change in the fair value of debt of $3,412
Interest expense($370,000 × 12% × 6/12) 22,200
Discount on bonds payable 200
Cash($400,000 × 11% × 6/12) 22,000
Interest expense([$370,000 + 200] × 12% × 6/12) 22,212
Discount on bonds payable 212
Cash($400,000 × 11% × 6/12) 22,000
Bonds Payable $400,000
less: Discount (29,588) $30,000– 200 - 212
Book Value $370,412
Gain-N/I 2,000
Gain-OCI 3,412
Fair value $365,000

AICPA:
Blooms: Apply
Difficulty: 3 Hard
10-59
35. On January 1, 2023, Ozark Minerals issued $20 million of 9%, ten-year convertible bonds at
101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible
into forty shares of Ozark's no par ordinary shares. Bonds that are similar in all respects,
except that they are nonconvertible, currently are selling at 99. Upon issuance, Ozark
should ______.
A. credit bonds payable $20,000,000 and discount on bonds payable $200,000
B. credit bonds payable $20,000,000 and premium on bonds payable $200,000
C. credit bonds payable $20,000,000 and equity $200,000
D. credit bonds payable $20,200,000

Fair value of bonds = $20,000,000 × 0.99 = $19,800,000
Principal amount = $20,000,000
Discount on bonds = $200,000
Equity = Proceeds − Fair value of bonds = $20,200,000 − $19,800,000 = $400,000.
Dr Cash $20,200,000
Dr Discount on bonds payable $200,000
Cr Bonds payable $20,000,000
Cr Equity options $400,000

AICPA:
Blooms: Apply
10-60
36. On December 15, 2023, Lin Corporation had on its books a carrying amount of $456,000 of
convertible bonds and the carrying amount of $100,000 of equity options in shareholders'
equity. Both of these items relate to convertible bonds issued in 2015. The principal
amount of the bonds remaining on that date was $500,000. Each $1,000 bond is
convertible into forty shares of Lin's no-par ordinary shares. Thirty percent of the bonds
were converted on December 16, 2023. The market price of Lin's share was $11 on that
date. Lin should ______.
A. credit share capital $163,200
B. credit share capital $220,000
C. credit share capital $166,800
D. credit share capital $136,800
Dr Bonds payable $150,000
Dr Equity options $30,000
Cr Discount on bonds $13,200
Cr Share capital $166,800

AICPA:
Blooms: Apply
Matching Questions
10-61
37. Listed below are four terms followed by a list of phrases that describe or characterize each
of the terms. Match each phrase with the most correct term.
The amount by which the reacquisition

1. Stock warrant price of debt exceeds book value. 3
2. Fair value option Protects the debt issuer if rates fall. 4
3. Loss on Gain or loss from own credit risk reported
extinguishment in other comprehensive income. 2
Right of an investor to purchase a
4. Call feature specific number of shares at a fixed price. 1

AICPA: BB Legal
AICPA: FN Measurement
Blooms: Understand
Topic: Bonds with detachable warrants
38. Listed below are four terms followed by a list of phrases that describe or characterize each
1. Times interest earned ratio Measures ability to service debt. 1

2. Debt to equity ratio Measures default risk. 2
3. Zero coupon bonds Bought at a deep discount. 3
4. Convertible bonds May become equity shares. 4

AICPA: BB Legal
Blooms: Understand
10-62
Learning Objective: 10-01 Identify the underlying characteristics of debt instruments and describe the basic approach to
accounting for debt.
financial ratios.
Topic: Bond indenture
Topic: Decision-makers' perspective
39. Listed below are five terms followed by a list of phrases that describe or characterize each
1. Discount on bonds Market rate less than stated rate. 3

2. Installment notes Market rate higher than stated rate. 1
3. Premium on bonds Many separate maturity dates. 4
4. Serial bonds No maturity payment. 2
5. Debt issue costs Legal, accounting, printing. 5

AICPA: BB Resource Management
Blooms: Understand
Topic: Debt issue costs
Topic: Long-term notes
10-63
40. Listed below are five terms followed by a list of phrases that describe or characterize each
of the terms. Match each phrase with the correct term.
1. Straight-line Additional consideration is recorded as

method an expense. 4
2. Warrants No gain or loss recorded. 5
3. Zero coupon Often traded separately from associated
bonds bonds. 2
4. Induced Requires(s) no cash outflow before
conversion maturity. 3
5. Conversion of A practical expediency in US GAAP but
bonds not in IFRS. 1

Blooms: Understand
Topic: Bonds with detachable warrants
10-64
41.
Listed below are several terms and phrases associated with long-term debt. Match each
phrase with the most correct term.
1. Market rate higher than stated

rate Straight-line method 9
2. Debt issue costs May become stock 4
3. Mortgage bond Bond price 10
Protection against
4. Convertible bonds falling rates 8
Legal, accounting,
5. Subordinated debenture printing 2
6. Balance times effective rate Discount 1
Name of owner not
7. Registered bonds registered 11
8. Call feature Bond indenture 15
9. Calculation of interest expense
permitted under US GAAP but not
IFRS Premium 13
10. Present value of interest plus
present value of principal Periodic cash payments 14
Checks are mailed
11. Coupon bonds directly 7
No specific assets
12. Debenture bond pledged 12
13. Stated rate higher than market
rate Backed by a lien 3
14. Principal amount times stated
rate Interest expense 6
Liquidation payments
15. Promises made to bondholders after other claims satisfied 5
10-65
AICPA: BB Legal
Blooms: Understand
Topic: Debt issue costs
Short Answer Questions
42. On January 1, 2018, Morton Sales Co. issued zero coupon bonds with a face value of $6
million for cash. The bonds mature in ten years and were issued at a price of $3,050,100.
Required: How much interest will Morton Sales Co. pay on these bonds in 2018?
None. Zero coupon bonds make no interest payments until maturity.

Blooms: Understand
10-66
Required: What was the annual effective interest rate in the market when the bonds were
issued?
7%
PV/FV = $3,050,100/$6,000,000 = .50835; when n = 10; I = 7%.

Blooms: Analyze
Difficulty: 3 Hard
Required: What amount of interest expense on these bonds would Morton Sales Co. report
in its 2018 income statement?
$213,507
Interest expense = Outstanding balance × Effective rate = $3,050,100 ×.07 = $213,507

10-67
Blooms: Apply
Difficulty: 3 Hard
Required: What will Morton Sales Co. report on these bonds in its December 31, 2018
balance sheet?
Bonds Payable: $3,263,607 (Issue price, plus accrued interest for 2018)

Blooms: Apply
Difficulty: 3 Hard
consideration.
10-68
Required: What total interest expense will Morton Sales Co. report over the ten-year life of
these bonds?
$2,949,900 (Maturity value of $6,000,000 − Issue price of $3,050,100)

Blooms: Analyze
Difficulty: 3 Hard
10-69
Determine the price of a $500,000 bond issue under each of the following independent
assumptions:
Maturity Interest Paid Stated Rate Effective Rate
1. Ten years Annually 10% 12%
2. Ten years Semiannually 10% 12%
3. Twenty years Semiannually 12% 10%
1. Interest $50,000 × 5.65022 = $282,511
Principal 500,000 × 0.32197 = 160,985
$443,496
2. Interest $25,000 × 11.46992 = $286,748
Principal 500,000 × 0.31180 = 155,900
$442,648
3. Interest $30,000 × 12.46221 = $373,866
Principal 500,000 × 0.37689 = 188,445
$562,311

Blooms: Apply
10-70
48. On January 1, 2018, Bishop Company issued 10% bonds dated January 1, 2018, with a face
maturity, the market yield is 12%. Interest is paid semiannually on June 30 and December
31.
Required:

2. Prepare the journal entry to record the bond issuance by Bishop on January 1, 2018.
method.
interest method.
1. Interest $1,000,000 × 11.46992 = $11,469,920
Principal $20,000,000 × 0.31180 = 6,236,000
$17,705,920
2. Cash 17,705,920
Discount on bonds payable 2,294,080
Bonds payable 20,000,000
3. Interest expense (6% × $17,705,920) 1,062,355
Discount on bonds payable 62,355
Cash (5% × $20,000,000) 1,000,000
4. Interest expense (6% [$17,705,920 + $62,355]) 1,066,097
Discount on bonds payable 66,097
Cash 1,000,000

10-71
Blooms: Apply
Difficulty: 3 Hard
10-72
49. On January 1, 2018, Mania Enterprises issued 12% bonds dated January 1, 2018, with a face
maturity, the market yield is 10%. Interest is paid semiannually on June 30 and December
31.
Required:

2. Prepare the journal entry to record the bond issuance by Mania on January 1, 2018.
method.
interest method.
1. Interest $1,200,000 × 12.46221 = $14,954,652
Principal $20,000,000 × 0.37689 = 7,537,800
$22,492,452
2. Cash 22,492,452
Premium on bonds payable 2,492,452
Bonds payable 20,000,000
3. Interest expense (5% × $22,492,452) 1,124,623
Premium on bonds payable 75,377
Cash (6% × $20,000,000) 1,200,000
4. Interest expense (5% [$22,492,452 − 75,377]) 1,120,854
Premium on bonds payable 79,146
Cash 1,200,000

10-73
Blooms: Apply
Difficulty: 3 Hard
10-74
50. Miranda Company contracted with Stewart Corporation to construct custom-made
equipment. The equipment was completed and ready for use on January 1, 2018. Miranda
paid for the machine by issuing a $200,000, three-year note that bears interest at the rate
of 4%, payable annually on December 31 each year. Since the machine was custom-built,
the cash price was unknown. However, when compared to similar contracts, 10% was
deemed to be a reasonable rate of interest.
Required:
1. Prepare the journal entry by Miranda to record the purchase of equipment.

2. Prepare journal entries to record interest for each of the first two years.
Interest $8,000 × 2.48685 = $19,895
Principal $200,000 × 0.75131 = 150,262
Present value at 10% $170,157
1. Equipment 170,157
Discount on notes payable 29,843
Notes payable 200,000
2. Year 1 Interest expense:
Interest expense (10% × $170,157) 17,016
Discount on notes payable (difference) 9,016
Cash (4% × $200,000) 8,000
Year 2 Interest expense:
Interest expense (10% × [$170,157 + 9,016]) 17,917
Discount on notes payable (difference) 9,917
Cash (4% × $200,000) 8,000
10-75
Blooms: Apply
Difficulty: 3 Hard
consideration.
Topic: Note exchanged for assets
10-76
prices. Book amounts and estimated fair values of our financial instruments other than
those for which book amounts approximate fair values as noted above are as follows (in
thousands)
2018 2017

percent and a principal amount at maturity on March 2, 2032 of approximately $308.8
million. The debentures are convertible at the option of the holder, at any time on or prior
to maturity, unless previously redeemed or otherwise purchased. The debentures have a
3,285,632 shares. The debentures may be redeemed at the option of the holder on March
2, 2022 or March 2, 2027, at the issue price plus accrued original discount totaling
Required: Explain why the estimated fair value of the debentures exceeds their book
amount at the end of fiscal year 2018.
Apparently, the current market interest rate is less than the effective rate (the rate at the
time the debentures were issued). This lower discount rate raises the current value
10-77
because the future expected cash flows are discounted by the market at the lesser rate.

Blooms: Analyze
financial ratios.
10-78
thousands)
2018 2017

Required: Why did the book amount of the debentures increase during fiscal year 2018?
These are zero coupon debentures. Therefore, Health Foods pays no annual interest in
cash, and the liability increases as interest accrues each year until maturity.
10-79
Blooms: Analyze
financial ratios.
10-80
thousands)
2018 2017

Required: What amount of interest expense will Health Foods accrue on the debentures
during fiscal year 2019?
$7,939,550
Interest expense = Book amount × 5% interest yield rate = $158,791,000 ×.05 =
10-81
$7,939,550

Blooms: Apply
financial ratios.
10-82
thousands)
2018 2017

Required: Determine the gain or loss that Health Foods would have reported in its 2018
income statement if it had redeemed (and retired) the debentures at fair value at the end
of the fiscal year.
Loss of $137,132,000
10-83
Cash paid would be $295,923,000; debt retired would be $158,791,000. The difference of
$137,132,000 would be the reported loss.

Blooms: Apply
10-84
55. On January 1, 2023, Comet Products issued $40 million of 6%, ten-year convertible bonds
at a net price of $40.8 million. The effective interest rate on the bond is 6.1352734%.
Comet recently issued similar, but nonconvertible, bonds at 99 (i.e., 99% of face amount).
The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into
thirty shares of Comet's no-par ordinary shares.
On June 1, 2025, Comet notified bondholders of its intent to call the bonds at face value
plus a 1% call premium on July 1, 2025. By June 30, all bondholders had chosen to convert
their bonds into shares as of the interestpayment date. On June 30, Comet paid the
semiannual interest and issued the requisite number of shares for the bonds being
converted.
Required:
1. Prepare the journal entry for the issuance of the bonds by Comet.
2. Prepare the journal entry for the June 30, 2023 interest payment.
3. Prepare the journal entries for the June 30, 2025 interest payment by Comet and the
conversion of the bonds (book value method).
4. Explain the difference in the accounting for convertible debt in US GAAP as compared to
theIFRS.
5. If Comet applies US GAAP in the preparation of its financial statements, how would the
journal entry in (1) and (2) differ?
Workings:
The fair value of the bond without the conversion option = 99% ×$40 million = $39.6
million
The unamortized discount at issue date = Principal (face) amount less the fair value of the
bond without the conversion option = $40 million - $39.6 million = $400,000
The amortization table for the bond from January 1, 2023 to June 30, 2025 is as follows:
Date Interest Payable Interest Expense Unamortized Discount Carrying Amount
January 1, $400,000.00 $39,600,000.00
10-85
2023
June 30, 2023 $1,200,000.00 $1,214,784.13 $385,215.87 $39,614,784.13
December 31, $1,200,000.00 $1,215,237.66 $369,978.21 $39,630,021.79

2023
June 30, 2024 $1,200,000.00 $1,215,705.09 $354,273.12 $39,645,726.88
December 31, $1,200,000.00 $1,216,186.87 $338,086.25 $39,661,913.75

2024
June 30, 2025 $1,200,000.00 $1,216,683.42 $321,402.83 $39,678,597.17
Requirement 1
Dr Cash 40,800,000
Dr Discount on bond 400,000
Cr Bond payable 40,000,000
Cr Equity options 1,200,000
Requirement 2
Dr Interest expense 1,214,784
Cr Discount on bond 14,784
Cr Cash 1,200,000
Requirement 3
Dr Interest expense 1,216,683
Cr Cash 1,200,000
10-86
Dr Bond payable 40,000,000
Dr Equity options 1,200,000
Cr Share capital 40,878,597
Requirement 4
Under US GAAP, convertible debt is not divided into its liability and equity elements. The
entire issue proceeds are accounted for as debt. The accounting for convertible debt is
treated in the same manner as with accounting for nonconvertible debt. The separation of
debt from equity using the fair value approach is not required. Interest expense is
computed based on the coupon rate and not the effective interest rate of an equivalent
pure bond.
Requirement 5
Under US GAAP, the entries on issue and interest payment are as follows:
Dr Cash 40,800,000
Cr Bond payable 40,000,00

Blooms: Apply
Learning Objective: 10-07 Discuss the primary differences between IFRS and U.S. GAAP with respect to accounting for
bonds and long-term notes.
10-87
56. Tru Fashions has bonds outstanding during a year in which the market rate of interest has
declined. If Tru has elected the fair value option for the bonds, will it report a gain or a loss
on the bonds for the year? Explain.
Falling interest rates, other factors remaining the same, cause prices of fixed rate securities
to rise. For the investor in these securities, the price increase represents a gain; but for Tru
Fashions, the debtor, the rise in the value of the liability is a loss. If Tru has elected the fair
value option for the bonds, it will report the loss on change in the fair value of the bonds in
its income statement to the extent it's due to changes in the general rate of interest. Any
change beyond that is reported as OCI.

AACSB: Communication
Blooms: Analyze
10-88
57. Heidi Baby Products issued 8% bonds with a face amount of $320 million on January 1,
2018. The bonds sold for $300 million. For bonds of similar risk and maturity, the market
yield was 9%. Upon issuance, Heidi elected the option to report these bonds at their fair
value. On June 30, 2018, the fair value of the bonds was $310 million as determined by
their market value on the NASDAQ. Will Heidi report a gain or will it report a loss when
adjusting the bonds to fair value? If the change in fair value is attributable to a change in
the general (risk-free) interest rate, did the rate increase or decrease? If the change in fair
value is attributable to a change in the general (risk-free) interest rate, is the gain or loss
reported as part of net income? Explain.
Heidi will report a loss (unrealized) when adjusting the bonds to fair value. An increase in
the fair value of a liability is a loss, just the opposite of an increase in the value of an asset.
If the change in fair value is attributable to a change in the general (risk-free) interest rate,
the rate decreased. This is because as interest rates fall, the value of a fixed rate
instrument, such as bonds, rises as occurred with Heidi's bonds. Heidi will report the loss
from the change in the fair value of the bonds in net income if the entire change is due to
the change in general interest rates. But any change in the fair value caused by a change in
the credit risk associated with the securities is reported as other comprehensive income
(OCI) in the statement of comprehensive income. Credit risk is the risk that the investor in
the bonds will not receive the promised interest and maturity amounts at the times they
are due. Companies can assume that any change in fair value that exceeds the amount
caused by a change in the general (risk-free) interest rate to be the result of credit risk
changes.

AACSB: Communication
Blooms: Analyze
10-89
10-90

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Chapter 10

Bonds and Long-Term Notes

True / False Questions

Multiple Choice Questions

Date Cash Interest Effective Interest Decrease in Balance Outstanding Balance

January 1, 2018 $207,020

June 30, 2018 $7,000 $6,211 $789 206,230

December 31, 7,000 6,187 813 205,417

June 30, 2019 7,000 6,163 837 204,580

December 31, 7,000 6,137 863 203,717

June 30, 2020 7,000 6,112 888 202,829

December 31, 7,000 6,085 915 201,913

June 30, 2021 7,000 6,057 943 200,971

December 31, 7,000 6,029 971 200,000

What is the annual stated interest rate on the bonds?

A. more than the effective interest

B. less than the effective interest

C. equal to the effective interest

D. more than if the bonds had been sold at a premium

B. is equal to the change in book value

A. the interest expense is less with each successive interest payment

B. more than $500,000

C. less than $500,000

D. the answer cannot be determined from the information provided

B. more than $500,000

C. less than $500,000

D. the answer cannot be determined from the information provided

20. Zero coupon bonds ______.

B. result in zero interest expense for the issuer

C. result in zero interest revenue for the investor

D. are reported as shareholders' equity by the issuer

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 300,000 345,639 45,639 8,640,967

2 300,000 347,464 47,464 8,686,606

3 300,000 349,363 49,363 8,734,070

What is the stated annual rate of interest on the bonds?

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 300,000 345,639 45,639 8,640,967

2 300,000 347,464 47,464 8,686,606

3 300,000 349,363 49,363 8,734,070

What is the effective annual rate of interest on the bonds?

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 300,000 345,639 45,639 8,640,967

2 300,000 347,464 47,464 8,686,606

3 300,000 349,363 49,363 8,734,070

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 300,000 345,639 45,639 8,640,967

2 300,000 347,464 47,464 8,686,606

3 300,000 349,363 49,363 8,734,070

What is the book value of the bonds as of December 31, 2019?

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 300,000 345,639 45,639 8,640,967

2 300,000 347,464 47,464 8,686,606

3 300,000 349,363 49,363 8,734,070

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 400,000 344,632 55,368 11,487,747

2 400,000 342,971 57,029 11,432,379

3 400,000 341,261 58,739 11,375,350

What is the effective annual rate of interest on the bonds?

Payment Cash Effective Interest Decrease in Balance Outstanding Balance

1 400,000 344,632 55,368 11,487,747

2 400,000 342,971 57,029 11,432,379

3 400,000 341,261 58,739 11,375,350