Chapter 14 Bonds and Long-Term Notes
True/False Questions
1. The specific provisions of a bond issue are described in a document called a bond indenture.
2. Periodic interest expense is the stated interest rate times the amount of debt outstanding during
the period.
3. The book value of zero-coupon bonds increases by the periodic amount of interest recognized.
4. Bonds will sell for a premium when the market rate of interest exceeds their stated rate.
5. The initial selling price of bonds represents the sum of all the future cash outflows required by
the obligation.
Chapter 14 Bonds and Long-Term Notes
6. Amortization of discount on bonds payable results in interest expense that is less than the
actual cash outflow.
7. Premium on bonds payable is a contra liability account.
8. An implicit or imputed rate of interest must be used when long-term notes are issued at a
stated rate of interest that is materially different from the market rate of interest.
9. The interest expense on an installment note decreases with each periodic payment.
Chapter 14 Bonds and Long-Term Notes
10. Paid-in capital is increased when bonds payable are issued with detachable stock purchase
warrants.
11. Companies are not required to, but have the option to, value some or all of their financial
assets and liabilities at fair value.
12. 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 credit risk.
Chapter 14 Bonds and Long-Term Notes
Multiple Choice Questions
13. The interest rate that is printed on the bond certificate is referred to as any of the following
except:
a. Stated rate.
b. Contract rate.
c. Nominal rate.
d. Effective rate.
14. Most corporate bonds are:
a. Mortgage bonds.
b. Debenture bonds.
c. Secured bonds.
d. Collateral bonds.
15. The method used to pay interest depends on whether the bonds are:
a. Registered or coupon.
b. Mortgaged or unmortgaged.
c. Indentured or debentured.
d. Callable or redeemable.
16. The rate of interest that actually is incurred on a bond payable is called the:
a. Face rate.
b. Contract rate.
c. Effective rate.
d. Stated rate.
Chapter 14 Bonds and Long-Term Notes
17. An investor purchases a 20-year, $1,000 par value bond that pays semiannual interest of $40.
If the semiannual market rate of interest is 5%, what is the current market value of the bond?
a. $ 828.
b. $ 893.
c. $1,000.
d. $1,686.
18. 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 face amount of the debt.
d. The stated interest rate times the face amount of the debt.
19. Bonds usually sell at their:
a. Maturity value.
b. Face value.
c. Present value.
d. Statistical expected value.
Chapter 14 Bonds and Long-Term Notes
20. Straight-line amortization of bond discount or premium:
a. Can be used for amortization of discount or premium in all cases and circumstances.
b. Provides the same amount of interest expense each period as does the effective interest
method.
c. Is appropriate for deep discount bonds.
d. Provides the same total amount of interest expense over the life of the bond issue as does
the effective interest method.
21. An amortization schedule for bonds issued at a premium:
a. Summarizes the amortization of the premium, a contra-asset account with a credit
balance.
b. Is reported in the balance sheet.
c. Is a schedule that reflects the changes in the debt over its term to maturity.
d. All of these answer choices are correct.
Use the following to answer questions 22–25:
Lopez Plastics Co. (LPC) issued callable bonds on January 1, 2016. LPC’s accountant has projected
the following amortization schedule from issuance until maturity:
Date
Cash interest
Effective interest
Decrease in balance
Outstanding balance
1/1/2016
$207,020
6/30/2016
$7,000
$6,211
$789
206,230
12/31/2016
7,000
6,187
813
205,417
6/30/2017
7,000
6,163
837
204,580
12/31/2017
7,000
6,137
863
203,717
6/30/2018
7,000
6,112
888
202,829
Chapter 14 Bonds and Long-Term Notes
12/31/2018
7,000
6,085
915
201,913
6/30/2019
7,000
6,057
943
200,971
12/31/2019
7,000
6,029
971
200,000
22. LPC issued the bonds:
a. At par.
b. At a premium.
c. At a discount.
d. Cannot be determined from the given information.
23. What is the annual stated interest rate on the bonds?
a. 3.5%
b. 6%
c. 7%
d. None of the answer choices is correct.
24. What is the annual effective interest rate on the bonds?
a. 3%
b. 3.5%
c. 6%
d. 7%
Chapter 14 Bonds and Long-Term Notes
25. LPC calls the bonds at 103 immediately after the interest payment on 12/31/2017 and retires
them. What gain or loss, if any, would LPC record on this date?
a. No gain or loss
b. $3,717 gain
c. $6,000 loss
d. $2,283 loss
26. Bonds are issued on June 1 that have interest payment dates of April 1 and October 1. Bond
interest expense for the year ended December 31, 2016, is for a period of:
a. Three months.
b. Four months.
c. Six months.
d. Seven months.
27. Ordinarily, the proceeds from the sale of a bond issue will be equal to:
a. The face amount of the bond.
b. The total of the face amount plus all interest payments.
c. The present value of the face amount plus the present value of the stream of interest
payments.
d. The face amount of the bond plus the present value of the stream of interest payments.
Chapter 14 Bonds and Long-Term Notes
28. 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.
29. When the interest payment dates are March 1 and September 1, and the bonds are issued on
July 1, the amount of interest expense reported in the December 31 income statement for the
year of issue would be for:
a. Six months.
b. Four months.
c. 10 months.
d. 12 months.
30. How would the book value of bonds payable be affected by the amortization of each of the
following?
Premium
Discount
a.
No effect
No effect
b.
No effect
Increase
c.
Increase
Decrease
d.
Decrease
Increase
31. For the issuer of 20-year bonds, the amount of amortization using the effective interest method
would decrease each year if the bonds are sold at a:
Discount
Premium
a.
No
No
Chapter 14 Bonds and Long-Term Notes
b.
No
Yes
c.
Yes
Yes
d.
Yes
No
32. For a bond issue that sells for more than the bond face amount, the effective interest rate is:
a. The rate printed on the face of the bond.
b. The Wall Street Journal prime rate.
c. More than the rate stated on the face of the bond.
d. Less than the rate stated on the face of the bond.
33. When bonds are sold at a premium and the effective interest method is used, at each
subsequent interest payment date, the cash paid is:
a. Less than the effective interest.
b. Equal to the effective interest.
c. Greater than the effective interest.
d. More than if the bonds had been sold at a discount.
34. 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.
Chapter 14 Bonds and Long-Term Notes
35. When bonds are sold at a discount and the effective interest method is used, at each interest
payment date, the interest expense:
a. Increases.
b. Decreases.
c. Remains the same.
d. Is equal to the change in book value.
36. 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.
37. When bonds are sold at a discount, if the annual straight-line amortization amount is compared
to the annual effective interest amortization amount over the life of the bond issue, the annual
amount of the straight-line amortization of discount is:
a. Higher than the effective interest amount every year.
b. Higher than the effective interest amount in the early years and less than the effective
interest amount in the later years.
c. Less than the effective interest amount in the early years and more than the effective
interest amount in the later years.
d. Less than the effective interest amount every year.
38. When bonds are sold at a premium, if the annual straight-line amortization amount is
compared to the annual effective interest amortization amount over the life of the bond issue,
the annual amount of the straight-line amortization of premium is:
a. Higher than the effective interest amount in the early years and less than the effective
interest amount in the later years.
b. Less than the effective interest amount in the early years and more than the effective
interest amount in the later years.
c. Higher than the effective interest amount every year.
d. Less than the effective interest amount every year.
39. 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.
40. On January 1, 2016, 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, 2016, in the amount of:
a. $ 8,850.
b. $10,000.
c. $10,620.
d. $12,000.
Chapter 14 Bonds and Long-Term Notes
41. A bond issue with a face 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.
42. On January 1, 2016, Solo Inc. issued 1,000 of its 8%, $1,000 bonds at 98. Interest is payable
semiannually on January 1 and July 1. The bonds mature on January 1, 2026. Solo paid
$50,000 in bond issue costs. Solo uses straight-line amortization. The amount of interest
expense for the year is:
a. $80,000.
b. $82,000.
c. $87,000.
d. $89,000.
43. On January 1, 2016, an investor paid $291,000 for bonds with a face amount of $300,000. The
stated rate of interest is 8% while the current market rate of interest is 10%. Using the
effective interest method, how much interest income is recognized by the investor in 2016
Chapter 14 Bonds and Long-Term Notes
(assume annual interest payments and amortization)?
a. $23,280.
b. $29,100.
c. $24,000.
d. $30,000.
44. 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.
45. The market price of a bond issued at a discount is the present value of its principal amount at
the market (effective) rate of interest:
a. Less the present value of all future interest payments at the rate of interest stated on the
bond.
b. Plus the present value of all future interest payments at the rate of interest stated on the
bond.
c. Plus the present value of all future interest payments at the market (effective) rate of
interest.
d. Less the present value of all future interest payments at the market (effective) rate of
interest.
46. On January 31, 2016, B Corp. issued $600,000 face value, 12% bonds for $600,000 cash. The
bonds are dated December 31, 2015, and mature on December 31, 2025. Interest will be paid
Chapter 14 Bonds and Long-Term Notes
semiannually on June 30 and December 31. What amount of accrued interest payable should B
report in its September 30, 2016, balance sheet?
a. $18,000.
b. $36,000.
c. $54,000.
d. $48,000.
Use the following to answer questions 47–51:
Discount-Mart issued ten thousand $1,000 bonds on January 1, 2016. The bonds have a 10-year term
and pay interest semiannually. This is the partial bond amortization schedule for the bonds.
Payment
Cash
Effective
Decrease in
Outstanding
Interest
Balance
Balance
8,640,967
1
300,000
345,639
45,639
8,686,606
2
300,000
347,464
47,464
8,734,070
3
300,000
349,363
49,363
8,783,433
4
300,000
47. What is the stated annual rate of interest on the bonds?
a. 3%.
b. 4%.
c. 6%.
d. 8%.
48. What is the effective annual rate of interest on the bonds?
a. 3%.
b. 4%.
c. 6%.
Chapter 14 Bonds and Long-Term Notes
d. 8%.
49. What is the interest expense on the bonds in 2017?
a. $700,700.
b. $600,000.
c. $347,464.
d. $100,700.
50. What is the book value of the bonds as of December 31, 2017?
a. $8,834,770.
b. $8,686,606.
c. $8,734,070.
d. $8,783,433.
51. What would be the total interest cost of the bonds over their full term?
Chapter 14 Bonds and Long-Term Notes
a. $1,359,033.
b. $4,640,967.
c. $6,000,000.
d. $7,359,033.
Chapter 14 Bonds and Long-Term Notes
Use the following to answer questions 52–56:
Prescott Corporation issued ten thousand $1,000 bonds on January 1, 2016. The bonds have a 10-year
term and pay interest semiannually. This is the partial bond amortization schedule for the bonds.
Payment Cash Effective Decrease in Outstanding
Interest Balance Balance
11,487,747
1 400,000 344,632 55,368 11,432,379
2 400,000 342,971 57,029 11,375,350
3 400,000 341,261 58,739 11,316,611
4 400,000
52. What is the stated annual rate of interest on the bonds?
a. 3%.
b. 4%.
c. 6%.
d. 8%.
53. What is the effective annual rate of interest on the bonds?
a. 3%.
b. 4%.
c. 6%.
d. 8%.
54. What is the interest expense on the bonds in 2017?
a. $800,000.
b. $680,759.
c. $342,971.
d. $119,241.
Chapter 14 Bonds and Long-Term Notes
55. What is the book value of the bonds as of December 31, 2017?
a. $11,432,379.
b. $11,375,350.
c. $11,316,611.
d. $11,256,109.
56. 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.
Use the following to answer questions 57–61:
Auerbach Inc. issued 4% bonds on October 1, 2016. The bonds have a maturity date of September 30,
2026 and a face value of $300 million. The bonds pay interest each March 31 and September 30,
Chapter 14 Bonds and Long-Term Notes
57. Auerbach issued the bonds:
a. At par.
b. At a premium.
c. At a discount.
d. Cannot be determined from the given information.
58. How much cash interest does Auerbach pay on March 31, 2017?
a. $ 6.0 million
b. $12.0 million
c. $ 9.0 million
d. $18.0 million
59. Assuming that Auerbach issued the bonds for $255,369,000, what interest expense would it
recognize in its 2016 income statement?
a. $0.
b. $3,830,535.
c. $5,107,380.
d. $7,661,070.
60. Assuming that Auerbach issued the bonds for $255,369,000, what would the company report
for its net bond liability balance at December 31, 2016, rounded up to the nearest thousand?