978-1259722660 Chapter 14 Solution Manual Part 1

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QUESTIONS FOR

REVIEW OF KEY TOPICS

Question 14–1

Periodic interest is calculated as the effective interest rate times the amount of the

debt outstanding during the period. This same principle applies to the flip side of the

Question 14–2

Long-term liabilities are appropriately reported at their present values. The present

value of a liability is the present value of its related cash flows—specifically the

Question 14–3

Bonds and notes are very similar. Both typically obligate the issuing corporation

to repay a stated amount (e.g., the principal, par value, face amount, or maturity

value) at a specified maturity date. In return for the use of the money borrowed, the

Normally a company will borrow cash from a bank or other financial institution by

signing a promissory note. Corporations, especially medium- and large- sized firms,

Solutions Manual, Vol.2, Chapter 14 14–1

McGraw-Hill Education.

Chapter 14 Bonds and Long-Term Notes

Answers to Questions (continued)

Question 14–4

All of the specific promises made to bondholders are described in a bond

indenture. This formal agreement will specify the bond issue’s face amount, the stated

interest rate, the method of paying interest (whether the bonds are registered bonds or

coupon bonds), whether the bonds are backed by a lien on specified assets, and

Question 14–5

In order for Brandon to sell its bonds that pay only 11.5% stated interest in a

12.25% market, the bonds would have to be priced at a discount from face amount.

Question 14–6

The price will be the present value of the periodic cash interest payments (face

Solutions Manual, Vol.2, Chapter 14 14–2

McGraw-Hill Education.

Answers to Questions (continued)

Question 14–7

In a strict sense, it’s true that zero-coupon bonds pay no interest. “Zeros” offer a

return in the form of a “deep discount” from the face amount. Still, interest accrues at

the effective rate times the outstanding balance, but no interest is paid periodically.

Question 14–8

When bonds are issued at a premium, the debt declines each period because the

effective interest each period is less than the cash interest paid. The “overpayments”

Solutions Manual, Vol.2, Chapter 14 14–3

McGraw-Hill Education.

Answers to Questions (continued)

Question 14–9

By the effective interest method, interest expense is recorded each period as the

effective market rate of interest multiplied by the outstanding balance of the debt

An exception to the conceptually appropriate method of determining interest for

bond issues is the straight-line method. Companies are allowed to determine interest

indirectly by allocating a discount or a premium equally to each period over the term

The straight-line method results in a constant dollar amount of interest expense

each period. By the straight-line method, the amount of the discount to be reduced

Solutions Manual, Vol.2, Chapter 14 14–4

McGraw-Hill Education.

Answers to Questions (continued)

Question 14–10

For either publicly or privately issued debt securities, the issuing company will

incur costs in connection with issuing bonds or notes, such as legal and accounting

This approach has the appeal of reflecting the effect debt issue costs have on the

effective interest rate. Debt issue costs reduce the net cash the company receives from

This approach is consistent with IFRS and with the treatment of issue costs when

Question 14–11

When the stated interest rate is not indicative of the market rate at the time a note

If the value of the asset (or service) is not readily determinable, the implicit rate

The economic essence of a transaction should prevail over its outward appearance.

Solutions Manual, Vol.2, Chapter 14 14–5

McGraw-Hill Education.

Answers to Questions (continued)

Question 14–12

When notes are paid in installments, rather than a single amount at maturity,

installment payments typically are equal amounts each period. Each payment will

Determining periodic interest is the same as for a note whose principal is paid at

Question 14–13

For all long-term borrowings, disclosure should include (a) the fair values, (b) the

Question 14–14

Regardless of the method used to retire debt prior to its scheduled maturity date,

the gain or loss on the transaction is simply the difference between the book value of

Question 14–15

The entire issue price of convertible bonds is recorded as debt, precisely the same

Solutions Manual, Vol.2, Chapter 14 14–6

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Answers to Questions (continued)

Question 14–16

GAAP requires that the entire issue price of convertible bonds be recorded as debt,

The difference is based on the relative separability of the debt and equity features

of the two securities. In the case of convertible bonds, the two features of the security,

Question 14–17

Additional consideration a company provides to induce conversion of convertible

Question 14–18

Rising interest rates, other factors remaining the same, cause prices of fixed-rate

securities to fall. For the investor in these securities, the price decline represents a

Solutions Manual, Vol.2, Chapter 14 14–7

McGraw-Hill Education.

Answers to Questions (continued)

Question 14–19

Under International Financial Reporting Standards, unlike U.S. GAAP, convertible

debt is divided into its liability and equity elements. If a company prepares its

financial statements according to IFRS, it accounts for convertible bonds it issues for

Question 14–20

All bonds sell at their price plus any interest that has accrued since the last interest

date to simplify the process of paying and recording interest. The buyer is asked to

Question 14–21

By definition, a troubled debt restructuring involves some concessions on the part

of the creditor (lender). A creditor may feel it can minimize losses by restructuring a

debt agreement, rather than forcing liquidation. A troubled debt restructuring takes

one of two forms, with the second further categorized for accounting purposes:

Solutions Manual, Vol.2, Chapter 14 14–8

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Answers to Questions (concluded)

Question 14–22

Pratt has a gain of $2 million (the difference between the book value of the debt

and the fair value of the property transferred). Pratt also must adjust the book value of

Question 14–23

(a) When the total future cash payments are less than the book value of the debt, the

(b) When the total future cash payments exceed the book value of the debt, no

Solutions Manual, Vol.2, Chapter 14 14–9

McGraw-Hill Education.