Chapter 11 – Liabilities: Bonds Payable
1. A bond is simply a form of an interest-bearing note.
a.
True
b.
False
2. Bondholders are creditors of the issuing corporation.
a.
True
b.
False
3. Bondholder claims on the assets of the corporation rank ahead of stockholders.
a.
True
b.
False
4. A bond is usually divided into a number of individual bonds of $500 each.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
5. If the bondholder has the right to exchange a bond for shares of common stock, the bond is called a convertible bond.
a.
True
b.
False
6. The prices of bonds are quoted as a percentage of the bonds’ market value.
a.
True
b.
False
7. The face value of a term bond is payable at a single specific date in the future.
a.
True
b.
False
8. When a corporation issues bonds, it executes a contract with the bondholders, known as a bond debenture.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
9. The market rate of interest is affected by a variety of factors, including investors’ assessment of current economic
conditions.
a.
True
b.
False
10. When the market rate of interest is less than the contract rate for a bond, the bond will sell for a premium.
a.
True
b.
False
11. Bonds are sold at face value when the contract rate is equal to the market rate of interest.
a.
True
b.
False
12. The price of a bond is equal to the sum of the interest payments and the face amount of the bonds.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
13. If the market rate of interest is 8% and a corporation’s bonds bear interest at 7%, the bonds will sell at a premium.
a.
True
b.
False
14. The total interest expense over the entire life of a bond is equal to the sum of the interest payments plus the total
discount or minus the total premium related to the bond.
a.
True
b.
False
15. Premium on bonds payable may be amortized by the straight-line method if the results obtained by its use do not
materially differ from the results obtained by use of the interest method.
a.
True
b.
False
16. If the straight-line method of amortization is used, the amount of unamortized premium on bonds payable will
decrease as the bonds approach maturity.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
17. If the straight-line method of amortization of discount on bonds payable is used, the amount of yearly interest expense
will increase as the bonds approach maturity.
a.
True
b.
False
18. There are two methods of amortizing a bond discount or premium: the straight-line method and the double-declining-
balance method.
a.
True
b.
False
19. The effective interest rate method of amortizing a bond discount or premium is the preferred method.
a.
True
b.
False
20. The amount of interest expense reported on the income statement will be more than the interest paid to bondholders if
the bonds were originally sold at a discount.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
21. The amortization of a premium on bonds payable decreases bond interest expense.
a.
True
b.
False
22. If the amount of a bond premium on an issued 11%, 4-year, $100,000 bond is $12,928, the semiannual straight-line
amortization of the premium is $1,416.
a.
True
b.
False
23. If the amount of a bond premium on an issued 11%, 4-year, $100,000 bond is $12,928, the annual interest expense is
$5,500.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
24. To determine the six-month interest payment amount on a bond, you would take one-half of the market rate times the
face value of the bond.
a.
True
b.
False
25. Interest payments on 12% bonds with a face value of $20,000 and interest paid semiannually would be $2,400 every 6
months.
a.
True
b.
False
26. Amortization is the allocation process of writing off bond premiums and discounts to interest expense over the life of
the bond issue.
a.
True
b.
False
27. If bonds are sold for a discount, the carrying amount of the bonds is equal to the face value less the unamortized
discount.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
28. Both callable and noncallable bonds can be purchased by the issuing corporation in the open market.
a.
True
b.
False
29. There is a loss on redemption of bonds when bonds are redeemed above the carrying amount.
a.
True
b.
False
30. When a portion of a bond issue is redeemed, a related proportion of the unamortized premium or discount must be
written off.
a.
True
b.
False
31. A corporation often issues callable bonds to protect itself against significant declines in future interest rates.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
32. Callable bonds can be redeemed by the issuing corporation at the fair market price of the bonds.
a.
True
b.
False
33. Only callable bonds can be purchased by the issuing corporation before maturity.
a.
True
b.
False
34. Callable bonds are redeemable by the issuing corporation within the period of time and at the price stated in the bond
indenture.
a.
True
b.
False
35. The carrying amount of the bonds is defined as the face value of the bonds plus any unamortized discount or less any
unamortized premium.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
36. If bonds of $1,000,000 with unamortized discount of $10,000 are redeemed at 98, the gain on redemption of bonds is
$10,000.
a.
True
b.
False
37. Gains and losses on the redemption of bonds are reported as other income (loss) on the income statement.
a.
True
b.
False
38. Discount on Bonds Payable is a contra liability account.
a.
True
b.
False
39. When there are material differences between the results of using the straight-line method and using the effective
interest rate method of amortization, the effective interest rate method should be used.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
40. Bonds payable should be reported on the balance sheet at face value plus or minus any unamortized premium or
discount.
a.
True
b.
False
41. The balance in a bond discount account should be reported on the balance sheet as a deduction from the related bonds
payable.
a.
True
b.
False
42. The balance in Premium on Bonds Payable should be reported as a deduction from Bonds Payable on the balance
sheet.
a.
True
b.
False
43. The higher the times interest earned ratio, the better the creditors’ protection.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
44. The times interest earned ratio is calculated by dividing Bonds Payable by Interest Expense.
a.
True
b.
False
45. An equal stream of periodic payments is called an annuity.
a.
True
b.
False
46. The buyer determines how much to pay for bonds by computing the present value of future cash receipts using the
contract rate of interest.
a.
True
b.
False
47. The present value of the periodic bond interest payments is the value today of the amount of interest to be received at
the end of each interest period.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
48. The present value of an annuity is the sum of the present values of each cash flow.
a.
True
b.
False
49. The present value of $5,000 to be received in 4 years at a market rate of interest of 6% compounded annually is
$3,636.30. Use the following table, if needed.
Present Value of $1 at Compound Interest
Periods
5%
6%
7%
10%
12%
1
0.95238
0.94340
0.93458
0.90909
0.89286
2
0.90703
0.89000
0.87344
0.82645
0.79719
3
0.86384
0.83962
0.81630
0.75132
0.71178
4
0.82270
0.79209
0.76290
0.68301
0.63552
5
0.78353
0.74726
0.71299
0.62092
0.56743
6
0.74622
0.70496
0.66634
0.56447
0.50663
7
0.71068
0.66506
0.62275
0.51316
0.45235
8
0.67684
0.62741
0.58201
0.46651
0.40388
9
0.64461
0.59190
0.54393
0.42410
0.36061
10
0.61391
0.55840
0.50835
0.38554
0.32197
a.
True
b.
False
50. One reason a dollar today is worth more than a dollar 1 year from today is the time value of money.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
51. If $500,000 of 10-year bonds, with interest payable semiannually are sold for $494,040 based on (1) the present value
of $500,000 due in 20 periods at 5% plus (2) the present value of twenty $25,000 payments at 5%, the nominal or contract
rate and the market rate of interest for the bonds are both 10%.
a.
True
b.
False
52. When the effective interest rate method of amortization is used, the amount of interest expense for a given period is
calculated by multiplying the face rate of interest by the bond’s carrying value at the beginning of the given period.
a.
True
b.
False
53. The effective interest rate method produces a constant dollar amount of interest expense to be reported each interest
period.
a.
True
b.
False
Chapter 11 – Liabilities: Bonds Payable
54. The concept of present value is that an amount of cash to be received at some date in the future is the equivalent of the
same amount of cash held at an earlier date.
a.
True
b.
False
55. A bond indenture is
a.
a contract between the corporation issuing the bonds and the underwriters selling the bonds
b.
the amount due at the maturity date of the bonds
c.
a contract between the corporation issuing the bonds and the bondholders
d.
the amount for which the corporation can buy back the bonds prior to the maturity date
56. When the corporation issuing the bonds has the right to redeem the bonds prior to the maturity, the bonds are
a.
convertible bonds
b.
unsecured bonds
c.
debenture bonds
d.
callable bonds
57. When the maturities of a bond issue are spread over several dates, the bonds are called
a.
serial bonds
b.
bearer bonds
c.
debenture bonds
d.
term bonds
Chapter 11 – Liabilities: Bonds Payable
58. The market interest rate related to a bond is also called the
a.
stated interest rate
b.
effective interest rate
c.
contract interest rate
d.
straight-line rate
59. If the market rate of interest is 7%, the price of 6% bonds paying interest semiannually with a face value of $500,000
will be
a.
equal to $500,000
b.
greater than $500,000
c.
less than $500,000
d.
greater than or less than $500,000, depending on the maturity date of the bonds
60. When the market rate of interest on bonds is higher than the contract rate, the bonds will sell at
a.
a premium
b.
their face value
c.
their maturity value
d.
a discount
Chapter 11 – Liabilities: Bonds Payable
61. The interest rate specified in the bond indenture is called the
a.
discount rate
b.
contract rate
c.
market rate
d.
effective rate
62. A legal document that indicates the name of the issuer, the face value of the bond and such other data is called
a.
trading on the equity
b.
convertible bond
c.
a bond debenture
d.
a bond indenture
63. Bonds that are subject to retirement prior to maturity at the option of the issuer are called
a.
debentures
b.
callable bonds
c.
early retirement bonds
d.
options
Chapter 11 – Liabilities: Bonds Payable
64. On January 1 of the current year, the Barton Corporation issued 10% bonds with a face value of $200,000. The bonds
are sold for $191,000. The bonds pay interest semiannually on June 30 and December 31 and the maturity date is
December 31, five years from now. Barton records straight-line amortization of the bond discount. The bond interest
expense for the year ended December 31 is
a.
$10,900
b.
$18,200
c.
$21,800
d.
$29,000
65. If $1,000,000 of 8% bonds are issued at 102 3/4, the amount of cash received from the sale is
a.
$1,080,000
b.
$972,500
c.
$1,000,000
d.
$1,027,500
66. If $2,000,000 of 10% bonds are issued at 97, the amount of cash received from the sale is
a.
$2,060,000
b.
$2,000,000
c.
$2,100,000
d.
$1,940,000
Chapter 11 – Liabilities: Bonds Payable
67. Selling the bonds at a premium has the effect of
a.
raising the effective interest rate above the stated interest rate
b.
attracting investors that are willing to pay a lower rate of interest than on similar bonds
c.
causing the interest expense to be higher than the bond interest paid
d.
causing the interest expense to be lower than the bond interest paid
68. If bonds are issued at a discount, it means that the
a.
bondholder will receive effectively less interest than the contractual rate of interest
b.
market interest rate is lower than the contractual interest rate
c.
market interest rate is higher than the contractual interest rate
d.
financial strength of the issuer is suspect
69. The Levi Company issued $200,000 of 12% bonds on January 1 of the current year at face value. The bonds pay
interest semiannually on January 1 and July 1. The bonds are dated January 1, and mature in five years, on January
1. The total interest expense related to these bonds for the current year ending on December 31 is
a.
$2,000
b.
$6,000
c.
$18,000
d.
$24,000
Chapter 11 – Liabilities: Bonds Payable
70. A corporation issues for cash $1,000,000 of 10%, 20-year bonds, interest payable annually, at a time when the
market rate of interest is 12%. The straight-line method is adopted for the amortization of bond discount or
premium. Which of the following statements is true?
a.
The amount of the annual interest expense is computed at 10% of the bond carrying amount at the beginning
of the year.
b.
The amount of the annual interest expense gradually decreases over the life of the bonds.
c.
The amount of unamortized discount decreases from its balance at issuance date to a zero balance at
maturity.
d.
The bonds will be issued at a premium.
71. If the straight-line method of amortization of bond premium or discount is used, which of the following statements is
true?
a.
Annual interest expense will increase over the life of the bonds with the amortization of bond premium.
b.
Annual interest expense will remain the same over the life of the bonds with the amortization of bond
discount.
c.
Annual interest expense will decrease over the life of the bonds with the amortization of bond discount.
d.
Annual interest expense will increase over the life of the bonds with the amortization of bond discount.
72. Basil Corporation issues for cash $1,000,000 of 8%, 10-year bonds, interest payable annually, at a time when the
market rate of interest is 7%. The straight-line method is adopted for the amortization of bond discount or
premium. Which of the following statements is true?
a.
The carrying amount increases from its amount at issuance date to $1,000,000 at maturity.
b.
The carrying amount decreases from its amount at issuance date to $1,000,000 at maturity.
c.
The amount of annual interest paid to bondholders increases over the 10-year life of the bonds.
d.
The amount of annual interest expense decreases as the bonds approach maturity.