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Chapter 3
Bonds Payable & Other Concepts

NAME: Date:
Professor: Section: Score:

QUIZ 1:
1. The result on the year-end balance sheet of an issue of a 10-year term bond sold at face amount
four years ago with interest payable June 1 and December 1 each year, is a(an)
a. liability for accrued interest c. increase in deferred charges
b. addition to bonds payable d. contingent liability

2. Unamortized bond discount should be reported on the financial statements of the issuer as a
a. Direct deduction from the face amount of the bond
b. Direct deduction from the present value of the bond
c. Deferred charge
d. Part of the issue costs

3. Straight-line amortization of bond premium or discount:


a. can be used as an optional method of amortization in all situations.
b. provides the same total amount of interest expense and interest revenue as the effective
interest method over the life of the bonds.
c. provides the same amounts of interest expense and interest revenue each interest period as
the effective interest method.
d. is appropriate when the bond term is especially long.
e. is appropriate for deep discount bonds.

4. For a bond issue which sells for less than its face amount, the market rate of interest is
a. Dependent on the rate stated on the bond.
b. Equal to rate stated on the bond.
c. Less than rate stated on the bond.
d. Higher than rate stated on the bond.

5. The market price of a bond issued at a discount is the present value of its principal amount at the
market (effective) rate of interest
a. Less the present value of all future interest payments at the market (effective) rate of interest.
b. Less the present value of all future interest payments at the rate of interest stated on the
bond.
c. Plus the present value of all future interest payments at the market (effective) rate of interest.
d. Plus the present value of all future interest payments at the rate of interest stated on the
bond.

6. Which of the following is not a relevant consideration when evaluating whether to derecognize
a financial liability?
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a. Whether the obligation has been discharged.


b. Whether the obligation has been canceled.
c. Whether the obligation has expired.
d. Whether substantially all the risks and rewards of the obligation have been transferred.

7. What is the effective interest rate of a bond or other debt instrument measured at amortized
cost?
a. The stated coupon rate of the debt instrument.
b. The interest rate currently charged by the entity or by others for similar debt instruments
(i.e., similar remaining maturity, cash flow pattern, currency, credit risk, collateral, and
interest basis).
c. The interest rate that exactly discounts estimated future cash payments or receipts through
the expected life of the debt instrument or, when appropriate, a shorter period to the net
carrying amount of the instrument.
d. The basic, risk-free interest rate that is derived from observable government bond prices.

8. Which of the following statements is false?


a. Bonds carry no corporate ownership privileges.
b. A bond is a financial contract.
c. Bond prices remain fixed over time.
d. A bond issuer must pay periodic interest.

9. Most bonds:
a. are money market securities.
b. are floating-rate securities.
c. give bondholders a voice in the affairs of the corporation.
d. are interest-bearing obligations of governments or corporations.

10. In an “asset swap,” where a liability is settled through the transfer of noncash asset,
a. the gain or loss on settlement is computed as the difference between the carrying amount of
the liability extinguished and the fair value of the noncash asset transferred.
b. the gain or loss on settlement is computed as the difference between the carrying amount of
the liability extinguished and the carrying amount of the noncash asset transferred.
c. the gain or loss on settlement is computed as the difference between the carrying amount of
the liability extinguished and the more clearly determinable between the fair value of the
liability extinguished and the carrying amount of the noncash asset transferred.
d. no gain or loss is recognized

“There is a time for everything, and a season for every activity under the
heavens;” (Ecclesiastes 3:1)

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NAME: Date:
Professor: Section: Score:

QUIZ 2:
1. On January 2, 20x1, Nast Co. issued 8% bonds with a face amount of ₱1,000,000 that mature on
January 2, 20x7. The bonds were issued to yield 12%, resulting in a discount of ₱150,000. Nast
incorrectly used the straight-line method instead of the effective interest method to amortize the
discount. How is the carrying amount of the bonds affected by the error?

At Dec. 31, 20x1 At Jan. 2, 20x7 At Dec. 31, 20x1 At Jan. 2, 20x7
a. Overstated Understated c. Understated Overstated
b. Overstated No effect d. Understated No effect

2. On July 1, 2003, after recording interest and amortization, York Co. converted ₱1,000,000 of its
12% convertible bonds into 50,000 shares of ₱1 par value ordinary share. On the conversion date
the carrying amount of the bonds was ₱1,300,000, the fair value of the bonds was ₱1,400,000, and
York’s ordinary share was publicly trading at ₱30 per share. What amount of share premium
should York record as a result of the conversion?
a. 950,000 b. 1,250,000 c. 1,350,000 d. 1,500,000

3. On April 30, 20x5, Witt Corp. had outstanding 8%, ₱1,000,000 face amount, convertible bonds
maturing on April 30, 20x9. Interest is payable on April 30 and October 31. On April 30, 20x5, all
these bonds were converted into 40,000 shares of ₱20 par ordinary share. On the date of
conversion:
 Unamortized bond discount was ₱30,000.
 Each bond had a fair value of ₱1,080.
 Each share of stock had a fair value of ₱28.

What amount should Witt record as a loss on conversion of bonds?


a. 150,000 b. 110,000 c. 30,000 d. 0

4. Ray Corp. issued bonds with a face amount of ₱200,000. Each ₱1,000 bond contained detachable
stock warrants for 100 shares of Ray's common stock. Total proceeds from the issue amounted to
₱240,000. The fair value of each warrant was ₱2, and the fair value of the bonds without the
warrants was ₱196,000. The bonds were issued at a discount of
a. 0 b. 678 c. 4,000 d. 33,898

5. On June 30, 20x9, King Co. had outstanding 9%, ₱5,000,000 face value bonds maturing on June
30, 2x14. Interest was payable semiannually every June 30 and December 31. On June 30, 20x9,
after amortization was recorded for the period, the unamortized bond premium and bond issue
costs were ₱30,000 and ₱50,000, respectively. On that date, King acquired all its outstanding
bonds on the open market at 98 and retired them. At June 30, 20x9, what amount should King
recognize as gain on redemption of bonds?
a. 20,000 b. 80,000 c. 120,000 d. 180,000
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6. On July 31, 20x0, Dome Co. issued ₱1,000,000 of 10%, 15-year bonds at par and used a portion of
the proceeds to call its 600 outstanding 11%, ₱1,000 face value bonds, due on July 31, 2x10, at
102. On that date, unamortized bond premium relating to the 11% bonds was ₱65,000. In its 20x0
income statement, what amount should Dome report as gain or loss, before income taxes, from
retirement of bonds?
a. 53,000 gain b. 0 c. (65,000) loss d. (77,000) loss

7. During 20x4 Peterson Company experienced financial difficulties and is likely to default on a
₱500,000, 15%, three-year note dated January 1, 20X2, payable to Forest National Bank. On
December 31, 20X4, the bank agreed to settle the note and unpaid interest of ₱75,000 for 20X4 for
₱50,000 cash and marketable securities having a carrying amount of ₱375,000. Peterson's
acquisition cost of the securities is ₱385,000. What amount should Peterson report as a gain from
the debt restructuring in its 20x4 income statement?
a. 65,000 b. 75,000 c. 140,000 d. 150,000

8. Casey Corporation entered into a troubled-debt restructuring agreement with First State Bank.
First State agreed to accept land with a carrying amount of ₱85,000 and a fair value of ₱120,000
in exchange for a note with a carrying amount of ₱185,000. What amount should Casey report as
gain in its income statement?
a. 0 b. 35,000 c. 65,000 d. 100,000

9. Wood Corp., a debtor undergoing financial difficulties granted an equity interest to a creditor in
full settlement of a ₱28,000 debt owed to the creditor. At the date of this transaction, the equity
interest had a fair value of ₱25,000 and par value of ₱20,000. What amount should Wood
recognize as gain on restructuring of debt?
a. 0 b. 3,000 c. 5,000 d. 8,000

10. In 20X2, May Corp. acquired land by paying ₱75,000 down and signing a note with a maturity
value of ₱1,000,000. On the note’s due date, December 31, 20X7, May owed ₱40,000 of accrued
interest and ₱1,000,000 principal on the note. May was in financial difficulty and was unable to
make any payments. May and the bank agreed to amend the note as follows:
 The ₱40,000 of interest due on December 31, 20X7, was forgiven.
 The principal of the note was reduced from ₱1,000,000 to ₱950,000 and the maturity date
extended 1 year to December 31, 20X8.
 May would be required to make one interest payment totaling ₱30,000 on December 31,
20X8.
 The original effective interest rate is 10% while the current market rate on December 31, 20X7
is 12%.

As a result of the troubled debt restructuring, May should report a gain, before taxes, in its 20X7
income statement of
a. 0 b. 165,000 c. 60,000 d. 149,092

“Blessed are the pure in heart, for they will see God.” (Matthew 5:8)
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SOLUTIONS TO QUIZ 2:

1. B
Solution:
EFFECT ON DECEMBER 31, 20X1:
Using straight line method:
Discount on bonds - 1/2/x1 150,000
Divide by: Term 6
Annual amortization of discount 25,000

Discount on bonds - 1/2/x1 150,000


Amortization - 20x1 (25,000)
Discount on bonds - 12/31/x1 125,000

Face amount 1,000,000


Discount on bonds - 12/31/x1 (125,000)
Carrying amount - 12/31/x1 875,000

Using effective interest method:


Date Interest expense Payments Amortization Present Value
1/2/x1 850,000
12/31/x1 102,000 80,000 22,000 872,000

Carrying amounts - 12/31/x1:


Straight line (erroneous) 875,000
Effective interest method 872,000
Difference - overstatement (3,000)

EFFECT ON JANUARY 2, 20X7:


On January 2, 20x7, maturity date, there will be NO EFFECT of the error on the carrying amount of the
bonds because on this date, the discount would have been fully amortized under both the straight line
method and the effective interest method.

2. B
Solution:
Carrying amount of bonds converted 1,300,000
Par value of shares issued (50,000 x 1) (50,000)
Share premium 1,250,000

3. D – No gain or loss is recognized when convertible bonds are converted into equity instrument.

4. C
Solution:
Fair value of bonds without the warrants 196,000
Face amount of bonds 200,000
Discount on bonds (4,000)

5. B
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Solution:
Redemption price (5M x 98%) 4,900,000
Less: Carrying amount of bonds:
Face amount 5,000,000
Unamortized premium 30,000
Unamortized issue costs (50,000) 4,980,000
Gain on retirement 80,000

6. A
Solution:
Redemption price (600 x 1,000 x 102%) 612,000
Less: Carrying amount of bonds:
Face amount (600 x 1,000) 600,000
Unamortized premium 65,000 665,000
Gain on retirement 53,000

7. D
Solution:
Payment for the liability:
Cash 50,000
Carrying amount of investment securities 375,000 425,000
Carrying amount of liability settled:
Principal 500,000
Accrued interest 75,000 575,000
Gain on settlement 150,000

8. D (185,000 carrying amt. of note - 85,000 carrying amt. of land) = 100,000 gain

9. B (28,000 – 25,000) = 3,000

10. D
Solution:
The modification is analyzed as follows:
Old terms New terms
Principal 1,000,000 950,000
Accrued interest 40,000 30,000
Remaining term ('n') 1 year

The present value of the modified liability is computed as follows:


Future cash flows PV of 1 @10%, n=1 Present value
Principal 950,000 0.90909 863,636
Interest 30,000 0.90909 27,273
Present value of the modified liability 890,908

The difference between the old liability and the new liability is tested for substantiality.
Carrying amount of old liability
1,040,000
(1M principal + 40,000 accrued interest)
Present value of modified liability 890,908
Difference 149,092
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Difference 149,092
Divide by: Carrying amount of old liability 1,040,000
14.34%

The modification is considered substantial because the modification resulted to a present value of the
new obligation different by at least 10% of the present value (carrying amount) of old obligation.
Therefore, the old liability is extinguished and the difference of ₱149,092 is recognized as gain on
extinguishment.