Financial Accounting, 10e (Libby)
Chapter 10 Reporting and Interpreting Bond Securities
1) An advantage of issuing a bond relative to stock is that most bond interest payments are tax
deductible.
2) Issuing bonds dilutes the voting power of the common shareholders because bonds have
preferential voting rights.
3) The major disadvantages of issuing a bond are the risk of bankruptcy and the negative impact
on cash flow because debt must be repaid at a specified date in the future.
4) A bond’s interest payments are determined by multiplying the bond’s principal amount by the
coupon rate.
5) A convertible bond can be called for early retirement at the option of the issuing company.
6) When the market rate of interest is greater than the coupon rate, the bond will sell at a
discount.
7) A bond will sell at a premium when the market rate of interest is greater than the coupon rate
of interest.
8) The proceeds received from a bond issue will be greater than the bond maturity value when
the coupon rate exceeds the market rate of interest.
9) Increases in the market rate of interest subsequent to a bond issue increase the discount on the
bond.
10) A bond will sell at its par value when the market rate of interest equals the coupon rate of
interest.
11) A company has a December 31 fiscal year-end and a bond on which interest is paid annually
on December 31. When the bond initially sells at par value, the bond interest expense on the
income statement equals the amount of the interest cash payment.
12) For bonds issued at par, the payment of bond interest on the interest payment date reduces
both the bond liability and assets, assuming that interest expense is recorded at the time of the
cash payment.
13) The issuing company and the trustee determine the selling price of a bond.
14) The issuance price of a bond is the present value of both the principal, plus the cash interest
to be received over the life of the bond, discounted at the coupon rate.
15) Amortization of discount on bonds payable will make the amount of interest expense less
than the cash owed for interest for that year.
16) Amortization of a discount on a bond payable will result in an increase in the book value of
the bond liability on the balance sheet.
17) A bond issued at a discount will pay more cash for interest over the life of the bond than the
total interest expense recognized over the life of the bond.
18) The journal entry for the cash payment of interest on a bond issued at a discount will result in
an increase in the book value of the bond liability.
19) Either straight-line or effective-interest amortization may be used for bond premiums or
discounts regardless of the amounts involved.
20) The journal entry for the cash payment of interest on a bond issued at a premium results in an
increase in the book value of the bond liability.
21) A bond issued at a premium will pay periodic cash interest in excess of the amount of
interest expense recognized for accounting purposes.
22) Interest expense decreases over time when a bond is initially issued at a premium and the
effective-interest method is used.
23) Interest expense increases over time when a bond is initially issued at a premium and the
effective-interest method is used.
24) The journal entry to record the issue of a bond when the coupon interest rate exceeds the
market rate of interest debits premium on bonds payable.
25) The debt-to-equity ratio is calculated by dividing total liabilities by total liabilities plus
stockholders’ equity.
26) The debt-to-equity ratio assesses the amount of capital provided by creditors relative to
stockholders’ equity.
27) Issuing bonds rather than stock will result in an increase in the debt-to-equity ratio.
28) If a company calls bonds with a $1,000,000 maturity value for $1,020,000 when the book
value is $950,000, a loss of $20,000 will be reported.
29) When a company purchases and retires its outstanding bonds payable for an amount less than
their book value, a decrease in stockholders’ equity results.
30) Issues of bonds in exchange for cash are reported as a cash flow from financing activities on
the statement of cash flows.
31) The cash payment for interest on a bond payable is reported as a cash flow from financing
activities on the statement of cash flows.
32) When a company prepares a bond indenture, certain provisions of the bonds are included.
Which of the following is not specified in the indenture?
A) Date of each interest payment.
B) The coupon interest rate.
C) The maturity date.
D) The market rate of interest.
33) Which of the following is the title of a regulatory document with regard to a bond offering?
A) Certificate
B) Covenant
C) Indenture
D) Prospectus
34) Which of the following types of bonds has specific assets pledged to guarantee repayment?
A) Debenture bond.
B) Callable bond.
C) Secured bond.
D) Convertible bond.
35) Which of the following is not a reason that a company 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 from using borrowed money may be positive.
D) There is less risk associated with a bond issue.
36) The annual interest rate specified within a bond indenture is called which of the following?
A) The coupon rate of interest.
B) The market rate of interest.
C) The effective rate of interest.
D) The actual rate of interest.
37) Which of the following statements best describes callable bonds?
A) They can be turned in for early retirement at the option of the bondholder.
B) They can be converted to common stock at the option of the bondholder.
C) They can be called for early retirement at the option of the issuer.
D) They can be called for early retirement at the option of the lien holder.
38) Which of the following statements best describes convertible bonds?
A) They can be turned in for early retirement at the option of the bondholder.
B) They can be converted to common stock at the option of the bondholder.
C) They can be called for early retirement at the option of the issuer.
D) They can be converted to common stock at the option of the issuer.
39) When a company needs funds to finance the expansion of its operations, which of the
following is not an advantage of issuing bonds rather than issuing stock?
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) Bonds can usually be issued at a low interest rate and the proceeds can be invested to earn a
higher rate.
D) The dates for the interest and maturity payments are fixed.
40) Which of the following statements is not correct?
A) The bond principal is the amount due at the maturity date of the bond.
B) The coupon rate is used to determine the cash interest payments.
C) The bond principal is used to determine the cash interest payments.
D) The market rate of interest is used to determine the cash interest payments.
41) Which of the following statements is correct?
A) A secured bond has specific assets pledged as collateral to secure it.
B) An unsecured bond can be paid at the option of the issuer.
C) A bond trustee is appointed to represent the issuing company.
D) The bond indenture specifies the market rate of interest the investors will earn.
42) Skylar Company issued $50,000,000 of its 10% bonds at par on January 1, 2019. On
December 31, 2019, the bonds were trading on the bond exchange at 102.5. Since the issue date,
what has happened to the market rate of interest?
A) The market rate increased.
B) The market rate decreased.
C) The market rate stayed the same.
D) The change in the market rate cannot be determined.
43) Eaton Company issued $5 million of bonds with a 10% coupon rate of interest.
When Eaton issued the bonds, the market rate of interest was 11%. Which of the following
statements is correct?
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) The book value of the bond will decrease as the bond matures.
44) Eaton Company issued $5 million of bonds with a 10% coupon rate of interest.
When Eaton issued the bonds, the market rate of interest was 8%. Which of the following
statements is incorrect?
A) The bonds were issued at a premium.
B) Annual interest expense will be less than the company’s annual cash payments for interest.
C) The book value of the bonds will decrease as the bond matures.
D) The annual interest expense will increase if the effective-interest method of amortization is
used.
45) Eaton Company issued $5 million of bonds with a 10% coupon rate of interest.
When Eaton issued the bonds, the market rate of interest was 10%. Which of the following
statements is incorrect?
A) The bonds were issued at par.
B) Annual interest expense will equal the company’s annual cash payments for interest.
C) The book value of the bonds will decrease as cash interest payments are made.
D) Annual interest expense is the same regardless of whether the effective-interest or straight-
line method of amortization is used.
46) Halverson’s times interest earned ratio was 2.98 in 2019, 2.79 in 2018, and 2.31 in 2017.
Which of the following statements about the ratio is correct?
A) The increasing ratio indicates decreasing levels of debt on which interest is incurred.
B) The increasing ratio indicates the strategy of pursuing growth by investment in other
companies, which has increased debt, but Halverson’s profits have not yet increased from those
investments.
C) The increasing ratio implies increased long-term debt financing.
D) The increasing ratio would be considered by creditors to be an indicator of higher risk.
47) During 2019, Patty’s Pizza reported net income of $4,212 million, interest expense of $167
million and income tax expense of $1,372 million. During 2018, Patty’s reported net income of
$3,568 million, interest expense of $163 million and income tax expense of $1,424 million. The
times interest earned ratios for 2019 and 2018, respectively, are closest to:
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.
48) Which of the following statements does not correctly describe the accounting for bonds that
were issued at their face (maturity) value?
A) The market rate of interest equals the coupon rate.
B) The interest expense over the life of the bonds will equal the total cash interest payments.
C) The present value of the bonds’ future cash flows equals the bonds’ maturity value.
D) The book value of the bond liability decreases when interest payments are made on the due
dates.
49) The journal entry to record the sale of bonds at their par value results in which of the
following?
A) An increase in assets and liabilities equal to the par value of the bonds.
B) An increase in assets and liabilities equal to the par value of the bonds and their associated
interest payments.
C) An increase in assets equal to the par value of the bonds and an increase in liabilities equal to
the bonds’ future cash flows.
D) An increase in assets and liabilities equal to the bonds’ future cash flows.
50) Assuming no adjusting journal entries have been made, the journal entry to record the cash
interest payment on the due date for bonds issued at their par value results in which of the
following?
A) An increase in expenses and a decrease in liabilities.
B) An increase in expenses and a decrease in assets.
C) A decrease in both liabilities and stockholders’ equity.
D) A decrease in both assets and liabilities.
51) Which of the following statements correctly describes the accounting for bonds that were
issued at a discount?
A) The market rate of interest is less than the coupon interest rate.
B) The interest expense over the life of the bonds will be less than the total cash interest
payments.
C) The present value of the bonds’ future cash flows is greater than the bonds’ maturity value.
D) The book value of the bond liability increases when interest payments are made on the due
dates.
52) Which of the following statements does not correctly describe the accounting for bonds that
were issued at a discount?
A) The interest expense over the life of the bond exceeds the total cash interest payments.
B) The interest expense over the life of the bonds increases as the bonds mature when the
effective interest method is used.
C) The amortization of the discount on bonds payable account decreases as the bonds mature
when the effective interest method is used.
D) The book value of the bond liability increases when interest payments are made on the due
dates when the effective interest method of amortization is used.