Chapter 14 Bonds and Long-Term Notes
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 14–1
Periodic interest is calculated as the effective interest rate times the amount of the
Question 14–2
Long-term liabilities are appropriately reported at their present values. The present
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
14–2 Intermediate Accounting, 8/e
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
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
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
Question 14–8
When bonds are issued at a premium, the debt declines each period because the
14–4 Intermediate Accounting, 8/e
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
(during the interest period). This simply is an application of the accrual concept,
consistent with accruing all expenses as they are incurred. The difference between the
Answers to Questions (continued)
Question 14–10
The prescribed treatment requires a debit to an asset account—”debt issue costs”—
which is then allocated to expense, usually on a straight-line basis. An appealing
alternative would be to reduce the recorded amount of the debt by the debt issue costs.
Question 14–11
When the stated interest rate is not indicative of the market rate at the time a note
is negotiated, the value of the asset (cash or noncash) or service exchanged for the
note establishes the market rate. This rate is the implicit rate of interest.
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
Question 14–13
Question 14–14
Regardless of the method used to retire debt prior to its scheduled maturity date,
Question 14–15
Answers to Questions (continued)
Question 14–16
GAAP requires that the entire issue price of convertible bonds be recorded as debt,
precisely the same way, in fact, as for nonconvertible bonds. On the other hand, the
issue price of bonds with detachable warrants is allocated between the two different
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
14–8 Intermediate Accounting, 8/e
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
Question 14–20
All bonds sell at their price plus any interest that has accrued since the last interest
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:
1. The debt may be settled at the time of the restructuring, or
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
14–10 Intermediate Accounting, 8/e
BRIEF EXERCISES
Brief Exercise 14–1
Brief Exercise 14–2
Interest $ 2,000,000 ¥ x 23.11477* = $46,229,540
Brief Exercise 14–3
Brief Exercise 14–4
Interest $ 2,500,000 ¥ x 27.35548* = $ 68,388,700
Brief Exercise 14–5
Interest will be the effective rate times the outstanding (book value) balance:
Brief Exercise 14–6
Interest will be the effective rate times the outstanding (book value) balance:
June 30
Brief Exercise 14–7
Interest will be a plug figure:
June 30
14–12 Intermediate Accounting, 8/e
Brief Exercise 14–8
Interest will be the effective rate times the outstanding balance:
June 30
December 31
Brief Exercise 14–9
December 31, 2016
Nantucket Ferry (Borrower)
Brief Exercise 14–10
Interest $6,000¥ x 2.72325 * = $ 16,340
14–14 Intermediate Accounting, 8/e
Brief Exercise 14–11
$300,000 ÷ 2.72325 = $110,162
Helpful, but not required:
Cash Effective Decrease in Outstanding
Payment Interest Balance Balance
5% x Outstanding Balance Balance Reduction
300,000
Brief Exercise 14–12
($ in millions)
Bonds payable (face amount) ……………………………….. 60.0
Brief Exercise 14–13
The issue price of bonds with detachable warrants is allocated between the two
different securities on the basis of their market values.
($ in millions)
Cash (102% x $60 million) ……………………………………………… 61.2
Brief Exercise 14–14
GAAP requires that the entire issue price of convertible bonds be recorded as
debt, precisely the same way, in fact, as for nonconvertible bonds.
14–16 Intermediate Accounting, 8/e
Brief Exercise 14–15
AI will report a gain when adjusting the bonds to fair value. A decrease in the fair
value of a liability is a gain, just the opposite of a decrease in the value of an asset.
EXERCISES
Exercise 14–1
The DD Corp. bonds are appropriately priced to yield the market rate of interest.
The GG Corp. bonds are slightly underpriced at the stated price and, therefore, are the
most attractive. The BB Corp. bonds are slightly overpriced and are the least
attractive. Bonds are priced to yield the market rate, 10% in this case. When this rate
is used to price the bonds, we get the prices shown below. Presumably, the market
rate changed since the underwriters priced two of the bond issues.
BB Corp. bonds:
DD Corp. bonds:
Interest $ 5,000,000 ¥ x 17.15909 * = $ 85,795,450
GG Corp. bonds:
Interest $ 4,500,000 ¥ x 17.15909 * = $77,215,905
14–18 Intermediate Accounting, 8/e
Exercise 14–2
1. Maturity Interest paid Stated rate Effective (market) rate
10 years annually 10% 12%
Interest $100,000 ¥ x 5.65022 * = $565,022
2. Maturity Interest paid Stated rate Effective (market) rate
10 years semiannually 10% 12%
Interest $50,000 ¥ x 11.46992 * = $573,496
3. Maturity Interest paid Stated rate Effective (market) rate
10 years semiannually 12% 10%
Interest $60,000 ¥ x 12.46221 * = $ 747,733
Exercise 14–2 (concluded)
4. Maturity Interest paid Stated rate Effective (market) rate
20 years semiannually 12% 10%
Interest $60,000 ¥ x 17.15909 * = $1,029,545
5. Maturity Interest paid Stated rate Effective (market) rate
20 years semiannually 12% 12%
Interest $60,000 ¥ x 15.04630 * = $902,778
14–20 Intermediate Accounting, 8/e
Exercise 14–3
1. Price of the bonds at January 1, 2016
Interest $4,000,000¥ x 11.46992 * = $45,879,680
2. January 1, 2016
Cash (price determined above) ……………………………….. 70,823,680
3. June 30, 2016
Interest expense (6% x $70,823,680) ………………………….. 4,249,421
Partial amortization schedule (not required)
Cash Effective Increase in Outstanding
Payment Interest Balance Balance
5% x Face Amount 6% x Outstanding Balance Discount Reduction
70,823,680
4. December 31, 2016