Chapter 10
Reporting and Interpreting Bonds
ANSWERS TO QUESTIONS
1. A company might choose to issue bonds instead of stock to avoid diluting
2. A bond is a liability that is issued to the investing public to raise capital. Bonds are
traded on established exchanges, such as the New York Bond Exchange. When a
3. Unsecured bonds are not backed by any type of asset as a guarantee of repayment
at maturity. Secured bonds are backed by specific assets as a guarantee of
repayment at maturity.
4. A bond indenture is a legal document that specifies all the details of a bond
5. Bond covenants are designed to protect bond investors but limiting what a
6. A bond’s coupon rate (also called the stated rate, contract rate, or nominal rate) is
the interest rate specified on a bond and is the rate used to compute the bond’s
7. The difference between a bond’s coupon rate and the market rate of interest
determines whether a bond is issued at a discount or a premium. When the coupon
8. The market interest rate reflects the return investor demand to invest in a security
with a given level of risk, so it is the rate used to discount a bond’s future cash
flows when calculating a bond’s present value.
9. The book value of a bond is the bond’s principle amount plus any premium or
10. The formula used to calculate the cash payment bond investors receive for interest
11. The debt-to–equity ratio is calculated by dividing total liabilities by total stockholders’
equity. The ratio describes the relationship between the amount of capital provided
by owners and the amount of capital provided by creditors.
12. When market interest rates increase, bond prices decrease. This concept is easily
ANSWERS TO MULTIPLE CHOICE
Financial Accounting, 9/e 10-3
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
Alternate
Problems
Cases and
Projects
No.
No.
Time
No.
1
1
15
1
10
11
12
13
14
17
10
11
12
13
14
15
40
45
45
15
15
45
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
2
10
2
10
2
30
2
30
2
20
3
5
3
20
3
30
3
30
3
20
4
5
4
20
4
20
4
35
4
30
5
10
5
15
5
25
5
35
5
30
6
15
6
10
6
30
6
30
6
25
7
15
7
15
7
45
7
35
7
8
10
8
20
8
45
8
35
10-4 Solutions Manual
MINI-EXERCISES
M10–1. 1. Balance Sheet
M10–2.
Principal
$600,000 0.45639
=
$273,834
Interest
$ 24,000* 13.59033
=
326,168
M10–3.
The times interest earned ratio is a better indicator. The debt-to-equity ratio
assesses how much debt relative to equity a company has in its capital structure.
M10–4.
The formula for the times interest earned ratio is:
Times Interest Earned = Net Income + Interest Expense + Income Tax
Interest Expense
M10–5.
Financial Accounting, 9/e 10-5
Principal
$900,000 0.43499
=
$391,491
M10–6.
January 1:
Cash (+A) ……………………………………………………………………
940,000
Bond discount (+XL, -L) ………………………………………………..
60,000
Bonds Payable (+L) ………………………………………………….
1,000,000
M10–7.
January 1:
Cash (+A) ……………………………………………………………………
940,000
Bonds Payable (+L) ………………………………………………….
940,000
=
M10–8.
Principal
$500,000 0.45639
=
$228,195
Interest
=
M10–9
January 1:
Cash (+A) ……………………………………………………………………
910,000
Bonds Payable (+L) ………………………………………………….
Bond premium (-L) ……………………………………………………….
M10–10
January 1:
Cash (+A) ……………………………………………………………………
910,000
Bonds Payable (+L) ………………………………………………….
910,000
Financial Accounting, 9/e 10-7
M10–11.
January 1:
Cash (+A) ……………………………………………………………………
580,000
Bond discount (+XL, –L) ………………………………………………..
20,000
Bonds Payable (+L) …………………………………………………..
600,000
M10–12.
January 1:
Cash (+A) ……………………………………………………………………
580,000
Bonds Payable (+L) …………………………………………………..
580,000
Interest Expense (+E, -SE) ($30,000 + $1,000) ………………..
31,000
Cash (-A) ($600,000 x .10 x ½) …………………………………..
30,000
M10–13.
If market interest rates fall after the issuance of a bond, the bond’s price will
increase. This is because the market interest rate is used to discount the bond’s
M10–14.
Cash paid for principle when a bond matures would be reported in the financing
section of the Statement of Cash Flows, while cash paid for interest would be
reported in the operating section.
Interest Expense (+E, –SE) ($30,000 + $1,000) ………………..
31,000
Cash (-A) ($600,000 x .10 x ½) …………………………………..
30,000
EXERCISES
E10–1.
Investors care about knowing the coupon rate because it determines the cash interest
E10–2.
If interest rates were to fall, companies might decide to call their bonds and issue
E10–3.
CASE A:
$100,000 x 0.58349 ………………………………………………
$ 58,349
$8,000* x 5.20637 ………………………………………………..
41,651
Issue price (market and stated rate same) ……………….
$100,000
CASE B:
$100,000 x 0.66506 ………………………………………………
$ 66,506
$8,000* x 5.58238 ………………………………………………..
Issue price (market rate less than stated rate) …………..
$111,165
(at a premium)
$100,000 x 0.54703 ………………………………………………
$ 54,703
$8,000* x 5.03295 …………………………..……………………
40,264
Issue price (market rate more than stated rate) …………
$ 94,967
(at a discount)
*$100,000 x .08
E10–4.
Financial Accounting, 9/e 10-9
CASE A:
$500,000 x 0.67297 ………………………………………………
$ 336,485
$15,000* x 16.35143 …………………………………………….
245,271
CASE B:
$500,000 x 0.55368 ………………………………………………
$ 276,840
$15,000* x 14.87747 …………………………………………….
223,162
Issue price (market rate same as coupon rate) …………
$500,002
(at par)
CASE C:
$500,000 x 0.43499 ………………………………………………
$ 217,495
$15,000* x 13.29437 …………………………………………….
199,416
Issue price (market rate greater than coupon rate) …….
$ 416,911
(at a discount)
E10–5.
Req. 1
At issuance, liabilities go up and equity is not affected so the debt–to-equity ratio
increased.
Req. 2
When Denver recognized interest expense, it decreased net income and decreased
E10–6.
Issue price (market rate less than coupon rate) …………
Applied Engineering’s ratios look better than Innovative Engineering’s ratios.
Applied Engineering has a lower debt-to-equity ratio than Innovative Engineering.
E10–7.
Present value:
$250,000 x 0.67556
=
168,890
$ 7,500* x 8.11090
=
60,832
=
E10–8.
Present value:
$600,000 x 0.71679
=
430,074
$ 22,500* x 6.66378
=
149,935
Issue price
=
$580,009
Cash (+A) ……………………………………………………………………
Bond discount (+XL, -L) ………………………………………………..
Bonds Payable (+L) …………………………………………………..
E10–8 (continued).
Req. 2
Financial Accounting, 9/e 10–11
June 30:
Interest Expense* (+E, -SE) ………………………………………….
24,650
Bond discount (-XL, +L) …………………………………………….
2,150
Cash (-A) …………………………………………………………………
22,500
*($580,009 x .085 x ½)
Req. 3
June 30:
E10–9.
Present value:
$600,000 x 0.71679
=
430,074
$ 22,500* x 6.66378
=
149,935
Issue price
=
$580,009
*$600,000 x .075 x 1/2
Cash (+A) ……………………………………………………………………
Bonds Payable (+L) …………………………………………………..
Long-term Liabilities
10–12 Solutions Manual
E10–9 (continued).
Req. 2
June 30:
Interest Expense* (+E, -SE) ………………………………………….
24,650
*($580,009 x .085 x ½)
Req. 3
June 30:
Balance sheet:
Long-term Liabilities
Bonds payable
E10–10.
Req. 1
Date
Cash
Interest
Interest Expense
Discount
Amortization
Book Value
of Bond
Jan. 1, Yr 1
$97,327
Dec. 31, Yr 1
$5,000*
$97,327 x .06 = $5,840
$840
98,167
Dec. 31, Yr 2
99,057
Dec. 31, Yr 3
100,00
*$100,000 x .05
Present value computation:
Principal:
$100,000 x .83962
$ 83,962
Interest:
5,000 x 2.67301
13,365
Issue price
$97,327
December 31:
Interest expense ……………….
$5,840
$5,890
22,500
Financial Accounting, 9/e 10–13
E10–11.
1. The bond issue price was $948. This is given in the amortization table. It can also
be computed by taking the present value of the future cash flows and discounting
them by the market interest rate of 8 percent.
4. (a) $1,000 x .06 = $60.
E10–12.
American specifies the coupon rate for the bonds, which determines the cash
E10–13.
Present value:
$2,000,000 x 0.43499
=
869,980
$ 100,000* x 13.29437
=
1,329,437
Issue price
=
$2,199,417
Year 1:
($948 + $16)
Year 2:
($964 + $17)
E10–13 (continued).
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
2,199,417
Bonds premium (+L) ………………………………………………….
199,417
Bonds Payable (+L) ………………………………………………….
2,000,000
Req. 2
Interest Expense (+E, –SE) ($2,199,417 x .0425) …………….
93,475
Bond premium (-L) ……………………………………………………….
Cash (-A) ($2,000,000 x .10 x ½) ………………………………..
Req. 3
Balance sheet:
Long-term Liabilities
Bonds payable
$2,192,892*
Financial Accounting, 9/e 10–15
E10–14.
Present value:
$2,000,000 x 0.43499
=
869,980
$ 100,000* x 13.29437
=
1,329,437
Issue price
=
$2,199,417
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
2,199,417
Bonds Payable (+L) ………………………………………………….
2,199,417
Req. 2
Interest Expense (+E, -SE) ($2,199,417 x .0425) …………….
93,475
Bonds Payable (-L) ………………………………………………………
Req. 3
Balance sheet:
Long-term Liabilities
Bonds payable
E10–15.
Req. 1
Date
Cash
Interest
Interest Expense
Premium
Amortization
Book Value
of Bond
Jan. 1, Yr 1
$10,278
Dec. 31, Yr 1
$500*
$10,278 x .04 = $411
$89
10,189
Dec. 31, Yr 2
500
10,189 x .04 = $408
92
10,097
Dec. 31, Yr 3
500
10,097 x .04 = $404
96
10,001**
*$10,000 x .05
Principal:
$10,000 x .88900
Interest:
500 x 2.77509
December 31:
Interest expense ……………….
E10–16.
Req. 1
Present value
$ 1,000,000 x .45639
=
456,390
$ 45,000* x 13.59033
=
611,565
$ 1,067,955**
Cash (+A) ……………………………………………………………………
Bonds payable (+L) …………………………………………………..
1,000,000
Bond premium (+L) ……………………………………………………
Financial Accounting, 9/e 10–17
E10–16 (continued).
Req. 2
E10–17.
Bonds payable (-L) ……………………………………………………….
1,000,000
Loss on bond call (+Loss, –SE) ………………………………………
50,000
Cash (-A) …………………………………………………………………
1,050,000*
*$1,000,000 x (1 +.05)
E10–18.
Bonds payable (-L) ……………………………………………………….
1,000,000
Loss on bond call (+Loss, –SE) ………………………………………
66,000
Cash (-A) …………………………………………………………………
1,050,000*
E10–19.
Bonds payable (-L) ……………………………………………………….
984,000
Loss on bond call (+Loss, –SE) ………………………………………
66,000
Cash (-A) …………………………………………………………………
1,050,000*
E10–20.
Present value:
$750,000 x 0.42241
=
316,808
$ 60,000* x 6.41766
=
385,060
Issue price
=
$701,868**
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
701,868
Bond discount (+XL, –L) ………………………………………………..
Bonds Payable (+L) …………………………………………………..
Req. 2
December 31:
Interest Expense (+E, –SE) ……………………………………………
Req. 3
December:
Balance sheet:
Long-term Liabilities
Bonds payable
$706,681*
Financial Accounting, 9/e 10–19
E10–21.
Present value:
$750,000 x 0.42241
=
316,808
$ 60,000* x 6.41766
=
385,060
Issue price
=
$701,868**
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
701,868
Bonds Payable (+L) …………………………………………………..
701,868
Req. 2
Interest Expense (+E, –SE) ……………………………………………
Req. 3
December 31:
Balance sheet:
Long-term Liabilities
Bonds payable
E10–22.
Present value:
$1,400,000 x 0.78941
=
1,105,174
$ 56,000* x 7.01969
=
393,103
Issue price
=
$1,498,277**
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
Bonds Payable (+L) ………………………………………………….
Req. 2
June 30:
Interest Expense (+E, –SE) ……………………………………………
43,715
Bonds premium (-L) ($98,277 / 8) …………………………..………
12,285
Cash (-A) …………………………………………………………………
56,000
Req. 3
June 30
Balance sheet:
Long-term Liabilities
Bonds payable
E10–23.