CHAPTER 3

PROBLEM 2:
PROBLEM 2: MULTIPLE CHOICE –
THEORY
1. C
2. C
3. A
4. D
5. C
6. D
7. C
8. C
Sample assumptions:
Face amount: 1M
Nominal int. rate: 10%
n=3
Effective int. rate: 12%
Initial carrying amount: (1M x PV
of 1 @12%, n=3) +
(100K x PV ord. annuity @12%,
n=3) = 951,963
Using effective interest method:

Date Interest Payments Amortization Present

  expense     Value

1/1/x1       951,963

12/31/x1 100,000 114,236 14,236 966,199

Using straight-line method:
Discount on bonds (1M – 951,963) 48,037
Divide by: Term 3
Annual amortization of discount 16,012

Carrying amount - 1/1/x1 951,963

Discount amortization - 20x1 16,012
Carrying amount - 12/31/x1 967,975

I .Effect on Bond carrying amount

967,975 SLM vs. 966,199 EIM = Overstated
II. Effect on Retained earnings
100K interest + 16,012 amort. = 116,012 int. expense
under SLM
116,012 SLM vs. 114,236 EIM: overstated
Effect on Retained earnings: Understated
9. B
Solution:
EFFECT ON DECEMBER 31, 20X1:
Using straight line method:
Discount on bonds - 1/2/x1 150,000
Divide by: Term 6
Annual amortization of discount 25,000
 
Discount on bonds - 1/2/x1 150,000
Amortization - 20x1 (25,000)
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
 Date Interest Payments   Present
  expense   Amortization Value
   
Using 1/2/       850,000
effective  
interest   102,000 80,000 22,000 872,000
method: 12/31/x1
•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.

10. C