Chapter 10 – Reporting and Interpreting Bonds
Chapter 10
Reporting and Interpreting Bonds
ANSWERS TO QUESTIONS
1. A bond is a liability that may or may not be secured by a mortgage on specified
assets. Bonds usually are in denominations of $1,000 or $10,000, are transferable
2. A bond indenture is an agreement drawn up by a company planning to sell a bond
issue. The indenture specifies the legal provisions of the bond issue such as
3. Secured bonds are supported by a mortgage or pledge of specific assets as a
guarantee of payment. Secured bonds are designated on the basis of the type of
4. Callable bonds—bonds that may be called for early retirement at the option of the
issuer.
5. Several important advantages of bonds compared with capital stock benefit the
issuer. The issuance of bonds establishes a fixed amount of liability and a fixed rate
6. The higher the tax rate is, the lower the net cost of borrowing money because the
interest paid on borrowed money is deductible on the income tax return of the
7. At the date of issuance, bonds are recorded at their current cash equivalent
8. When a bond is issued (sold) at its face amount, it is issued at par. In contrast,
when a bond is sold at an amount lower than the par amount, it is issued at a
discount, and conversely, when it is sold at a price above par, it is issued at a
9. The stated rate of interest is the rate specified on a bond, whereas the effective
rate of interest is the market rate at which the bonds are selling currently.
10. When a bond is sold at par, the stated interest rate and the effective or market
interest rate are identical. When a bond is sold at a discount, the stated rate of
Chapter 10 – Reporting and Interpreting Bonds
11. A bond issued at par will have a book or carrying value, or net liability, equal to the
par or principal of the bond. This amount should be reported as the carrying value
on each balance sheet date. When a bond is sold at a premium or discount, the
12. The basic difference between straight-line amortization and effective-interest
amortization of bond discount and premium is that, under straight-line amortization,
an equal amount of premium or discount is amortized to interest expense each
period. Straight-line amortization per interest period is computed by dividing the
total amount of the premium or discount by the number of periods the bonds will be
materially different from the results of the effective-interest method.
ANSWERS TO MULTIPLE CHOICE
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
Alternate
Problems
Cases and
Projects
No.
Time
No.
Time
No.
Time
No.
Time
No.
Time
1
5
1
10
1
40
1
20
1
25
2
5
2
10
2
30
2
30
2
20
3
5
3
10
3
30
3
35
3
20
4
5
4
15
4
40
4
40
4
30
5
5
5
15
5
50
5
40
5
30
6
5
6
15
6
45
6
35
6
25
7
5
7
10
7
45
7
25
7
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5
8
20
8
50
9
10
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12
5
5
5
5
17
20
9
10
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13
14
20
20
15
15
20
25
9
10
11
12
13
14
35
40
40
25
35
30
* 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
perceived difficulty of the task. You can reduce student frustration and anxiety by
Chapter 10 – Reporting and Interpreting Bonds
MINI-EXERCISES
M10–1. 1. Balance Sheet
2. Income Statement
M10–2.
Principal
$600,000 0.4564
=
$273,840
M10–3.
Principal
$900,000 0.4350
=
$391,500
M10–4.
January 1, 2011:
Cash (+A) ……………………………………………………………………
940,000
Discount on Bonds Payable (+XL, -L) ……………………………..
Bonds Payable (+L) ………………………………………………….
M10–5.
January 1, 2011:
Cash (+A) ……………………………………………………………………
580,000
Discount on Bonds Payable (+XL, -L) ……………………………..
Bonds Payable (+L) …………………………………………………..
Interest Expense (+E, –SE) ……………………………………………
Cash (-A) …………………………………………………………………
M10–6.
Principal
$500,000 0.4564
=
$228,200
M10–7.
January 1, 2011:
Cash (+A) ……………………………………………………………………
620,000
Bonds Payable (+L) ………………………………………………….
600,000
Interest Expense (+E, –SE) ……………………………………………
Premium on Bonds Payable (-L) …………………………..………..
Cash (-A) …………………………………………………………………
M10–8
January 1, 2011:
Cash (+A) ……………………………………………………………………
910,000
Bonds Payable (+L) ………………………………………………….
Premium on Bonds Payable (-L) …………………………..………..
Chapter 10 – Reporting and Interpreting Bonds
M10–9.
The debt-to-equity ratio and times interest earned ratio are both measures of the
M10–10.
If the interest rates fall after the issuance of a bond, the bond’s price will
M10–11.
When a company issues a bond at a discount, the interest expense each period
M10–12.
Cash paid to retire a bond would be reported in the financing activities section of
EXERCISES
E10–1.
1. Bond principal, par value, or face value
2. Par value or face value
E10–2.
The AT&T bonds have a coupon interest rate of 6.5%. If bonds with a $10,000 face
E10–3.
When a bond offers a conversion feature, its value will be affected by the value of the
common stock. As the price of the stock goes up, the bond becomes more valuable. In
the case of the Wynn bond, each $1,000 face value bond can be converted into
43.4782 shares of stock. Given that the stock now sells for $90 per share, each bond is
worth at least $3,913 based on this conversion feature. A bondholder who needs cash
Chapter 10 – Reporting and Interpreting Bonds
E10–4.
CASE A:
$100,000 x 0.5835 ………………………………………………..
$ 58,350
$8,000 x 5.2064 ……………………………………………………
41,651
Issue price (market and stated rate same) ……………….
$100,001
(at par; $1
rounding error)
CASE B:
$100,000 x 0.6651 ………………………………………………..
$ 66,510
$8,000 x 5.5824 ……………………………………………………
Issue price (market rate less than stated rate) …………..
$111,169
(at a premium)
CASE C:
$100,000 x 0.5132 ………………………………………………..
$ 51,320
$8,000 x 4.8684 ……………………………………………………
38,947
Issue price (market rate more than stated rate) …………
$ 90,267
(at a discount)
E10–5.
CASE A:
$500,000 x 0.6730 ………………………………………………..
$ 336,500
$15,000 x 16.3514 ………………………………………………..
245,271
Issue price (market rate less than stated rate) …………..
$581,771
(at a premium)
CASE B:
$500,000 x 0.5537 ………………………………………………..
$ 276,850
$15,000 x 14.8775 ………………………………………………..
Issue price (market rate and stated rate same) …………
$500,013
(at par, $13
CASE C:
rounding error)
$500,000 x 0.4564 ………………………………………………..
$ 228,200
$15,000 x 13.5903 ………………………………………………..
Issue price (market rate more than stated rate) …………
$ 432,055
(at a discount)
E10–6.
Applied Technologies’ ratios look better than Innovative Solutions’ ratios.
Applied Technologies has a lower debt-to-equity ratio than Innovative Solutions.
E10–7.
Computations:
Interest:
$100,000 x 6% x 1/2
=
$3,000
$100,000 x 0.6756
=
$ 3,000 x 8.1109
=
=
$91,893
E10–8.
Computations:
Interest:
$750,000 x 8%
=
$ 60,000
Present value:
=
$ 60,000 x 6.4177
=
=
$701,862
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
701,862
Discount on Bonds Payable (+XL, -L) ……………………………..
48,138
Bonds Payable (+L) …………………………………………………..
750,000
Req. 2
Interest Expense (+E, –SE) ……………………………………………
64,814
60,000
$ 64,814
Balance sheet:
Long-term Liabilities
Bonds payable
$750,000
Less: Unamortized discount ($48,138 – $4,814)
43,324
$706,676
Chapter 10 – Reporting and Interpreting Bonds
E10–9.
Computations:
Interest:
$600,000 x 7.5% x 1/2
=
$ 22,500
Present value:
$600,000 x 0.7168
=
$ 22,500 x 6.6638
=
=
$580,016
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
580,016
Discount on Bonds Payable (+XL, -L) ……………………………..
19,984
Bonds Payable (+L) …………………………………………………..
600,000
Req. 2
Interest Expense* (+E, -SE) ………………………………………….
24,651
22,500
Req. 3
June 30, 2011:
Income statement:
Interest expense
$ 24,651
Long-term Liabilities
Bonds payable
$600,000
Less: Unamortized discount ($19,984 – $2,151)
$582,167
E10–10.
Computations:
Interest:
$600,000 x 7.5% x 1/2
=
$ 22,500
$600,000 x 0.7168
=
$ 22,500 x 6.6638
=
=
$580,016
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
Bonds Payable (+L) …………………………………………………..
Req. 2
June 30:
Interest Expense* (+E, -SE) ………………………………………….
24,651
Bonds Payable (+L) …………………………………………………..
2,151
Cash (-A) …………………………………………………………………
22,500
*($580,016 x 8.5% x ½)
$ 24,651
Long-term Liabilities
Chapter 10 – Reporting and Interpreting Bonds
E10–11.
Req. 1
Issue price:
1. Par, $300,000 – Carrying value at end of 1 year, $281,100 = $18,900 (unamortized
discount for 9 remaining years).
Issuance entry:
Cash (+A) ……………………………………………………………………
279,000
Discount on bonds payable (+XL, -L) ………………………………
21,000
Bonds payable (+L) …………………………………………………..
300,000
Req. 2
Coupon (stated interest) rate:
1. Reported interest expense, $23,100 – Discount amortized, $2,100 = $21,000 (cash
interest).
Interest expense (+E, –SE) …………………………………………….
Discount on bonds payable ($21,000 ÷ 10 years) (-XL, +L)
Cash ($300,000 x 7%) (-A) …………………………………………
E10–12.
1. Issue price: $948. Stated rate, 6%; effective or yield rate, 8% (both were given).
2. Discount: $1,000 – $948 = $52.
2011
2012
2013
(immediately before retirement)
E10–12. (continued)
7. (a) $1,000 x 6% = $60.
8. Effective-interest amortization measures the amount of interest expense and net
liability for each period on a present value basis. The interest expense and related
E10–13.
The effective interest rate for a bond is determined by market forces and not the
company. American was able to specify the coupon rate for the bonds which
E10–14.
Students will typically offer one of two explanations:
• Normally, bonds that offer less than the market rate sell at a discount that
results in a bond yield equal to the market rate of interest. While this is
Chapter 10 – Reporting and Interpreting Bonds
E10–15.
Assuming that both companies offer the same business risk, many people might
prefer the bond that had the slightly higher yield which is Walt Disney at 9.5%. If
interest rates were to fall significantly, companies might decide to call their bonds
E10–16.
Computations:
Interest:
$1,400,000 x 8% x 1/2
=
$ 56,000
=
$ 56,000 x 7.0197
=
=
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
1,498,263
Premium on Bonds Payable (+L) ………………………………..
98,263
Bonds Payable (+L) ………………………………………………….
1,400,000
Req. 2
Interest Expense (+E, –SE) ……………………………………………
Premium on Bonds Payable (-L) …………………………..………..
Cash (-A) …………………………………………………………………
E10–16. (continued)
Req. 3
June 30, 2011:
Income statement:
Interest expense
$ 43,717
Long-term Liabilities
Bonds payable
$1,400,000
E10–17.
Computations:
Interest:
$2,000,000 x 5%
=
$ 100,000
Present value:
$2,000,000 x 0.4350
=
$ 100,000 x 13.2944
=
=
$2,199,440
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
2,199,440
Premium on Bonds Payable (+L) ………………………………..
199,440
Bonds Payable (+L) ………………………………………………….
2,000,000
Req. 2
Interest Expense (+E, –SE) ($2,199,440 x 4.25%) ……………
Premium on Bonds Payable (-L) …………………………..………..
Cash (-A) …………………………………………………………………
Req. 3
June 30, 2011:
Income statement:
Interest expense
$ 93,476
Long-term Liabilities
192,916
Chapter 10 – Reporting and Interpreting Bonds
E10–18.
Computations:
Interest:
$2,000,000 x 5%
=
$ 100,000
$2,000,000 x 0.4350
=
$ 100,000 x 13.2944
=
=
Req. 1
January 1:
Cash (+A) ……………………………………………………………………
2,199,440
Bonds Payable (+L) …………………………………………………..
2,199,440
Req. 2
Interest Expense (+E, -SE) ($2,199,440 x 4.25%) ……………
Bonds Payable (-L) ………………………………………………………
Cash (-A) …………………………………………………………………
Long-term Liabilities
Bonds payable
E10–19.
Req. 1
Date
Cash
Interest
Interest Expense
Premium
Amortization
Net Liability
Balance
1/1/2011
$10,278
12/31/2011
$500
$10,278 x 4% = $411
$89
10,189
12/31/2012
500
$10,189 x 4% = $408
92
10,097
12/31/2013
500
$10,097 x 4% = $404
96
10,001*
* $1 rounding error
$10,000 x .8890
Interest:
500 x 2.7751
December 31:
Interest expense ……………….
E10–20.
Req. 1
Cash is increased on the balance sheet. The statement of cash flows shows an
inflow from financing activities. Bonds payable and premium on bonds payable
Cash (+A) ……………………………………………………………………
Premium on bonds payable (+L) …………………………………
Bonds payable (+L) …………………………………………………..
Principal: $300,000 x .7441 …………………………………………..
Chapter 10 – Reporting and Interpreting Bonds
E10–20. (continued)
Req. 2
The interest expense will be increased on the income statement and the cash will
Req. 3
December 31, 2011:
Income Statement:
E10–21.
Req. 1
Computations:
Interest:
$1,000,000 x 10%
=
$100,000 ÷ 2 = $50,000
Present value
$ 1,000,000 x .4564
=
456,400
$ 50,000 x 13.5903
=
679,515
$ 1,135,915
E10–22.