PROBLEMS

PROBLEM 1: TRUE OR FALSE

1. Zero-interest bonds sell at a significant discount that provides an investor with a total
interest payoff at maturity
2. Callable bonds may be redeemed prior to maturity at the option of the issuer.
3. The term “junk bonds” is frequently applied to low-yield bonds.
4. If the stated interest rate for a bond issue exceeds the effective interest rate, the bonds
will sell at a discount.
5. Bond issuance costs must be reported separately as deferred charges and charged to
expense over the life of the bond issue.
6. Convertible bonds can be exchanged for another form of security, such as common
stock, at the option of the issuer.
7. The amortization of bond discount reduces interest expense to an amount less than the
interest actually paid to bondholders
8. When debt is retired prior to its maturity date, a gain or loss must be recognized for the
difference between the carrying amount of the debt security and the amount paid.
9. Under generally accepted accounting principles, gain or loss must be recognized on the
conversion of bonds into equity securities.
10. In-substance defeasance is a process of transferring assets to an irrevocable trust, using
the assets and earnings therefrom to satisfy the long-term debt as it comes due.

PROBLEM 2: FOR CLASSROOM DISCUSSION

1. In theory (disregarding any other marketplace variables), the proceeds from the sale of a
bond will be equal to

a. The face amount of the bond

b. The present value of the bond maturity value plus the present value of the
interest payments to be made during the life of the bond.
c. The face amount of the bond plus the present value of the interest payments
made during the life of the bond.
d. The sum of the face amount of the bond and the periodic interest payment

2. Unamortized debt premium should be reported on the balance sheet of the issuer as a
a. Direct addition to the face amount of the debt.
b. Direct addition to the present value of the debt.
c. Deferred credit
d. Deduction from the issue costs

3. Which one of the following is true when the effective-interest method of amortizing bond
discount is used?
a. Interest expense as a percentage of the bonds’ carrying amount varies from
period to period
b. Interest expense remains constant for each period
c. Interest expense increases each period
d. The interest rate decreases each period.
4. Scott. Inc, neglected to amortize the discount on outstanding ten-year bonds payable.
What is the effect of the failure to record discount amortization on interest expense and
bond carrying value, respectively?
a. Understate; understate c. Overstate; overstate
b. Understate; overstate d. Overstate; understate

5. Bond discount should be presented in the financial statements of the issuer as a(n)
a. Contra liability. c. Deferred charge
b. Adjunct liability d. Contra asset

6. DESTITUTE LACKING, Inc. issued P500,000, 10% bonds to yield 8%, Bond issuance
costs were P10,000. How should DESTITUTE calculate the net proceeds to be received
from the issuance?
a. Discount the bonds at the stated rate of interest
b. Discount the bonds at the market rate of interest
c. Discount the bonds at the stated rate of interest and deduct bond issuance
costs.
d. Discounts the bonds at the market rate of interest and deduct bond issuance
costs.

7. Any gains or losses from the early extinguishment of debt should be

a. Recognized in income of the period of extinguishment
b. Treated as an increase or decrease in Paid-in Capital
c. Allocated between a portion that is an increase (decrease) in Paid-in Capital
and a portion that is recognized in current income.
d. Amortized over the remaining original life of the extinguished debt

8. When bonds are retired prior to maturity with proceeds from a new bond issue, gain or
loss from the early extinguishment of debt, if material, should be
a. Amortized over the remaining original life of the retired bond issue
b. Amortized over the life of the new bond issue
c. Recognized as an extraordinary item in the period of extinguishment

9. When bonds are redeemed by the issuer prior to their maturity date, any material gain or
loss on the redemption, if material, is
a. Amortized over the period remaining to maturity and reported as an
extraordinary item in the income statement
b. Amortized over the period remaining to maturity and reported as part of
income from continuing operations in the income statement
c. Reported in the income statement as an extraordinary item in the period of
redemption
d. Reported in the income statement as part of income from continuing
operations in the period of redemption.

10. On January 1, 20x1, an entity issues bonds with face amount of P5,000,000 for
P4,800,000. The bonds mature on December 31, 20x3 and pay annual interest of 10%
 every December 31. The entity incurs bonds issue costs of P473,767. The effective interest
rate adjusted for bond issue costs is 16%.

Requirement:
a. Compute for the initial carrying amount of the bonds
b. Compute for net discount or a net premium (including the effect of the bond
issue cost) from the issuance on initial recognition.
c. Are the periodic interest payments greater than or less than the periodic
interest expense?
d. Prepare all the journal entries during the term of the bonds.

11. On April 1, 20x1, an entity issues bonds with face amount of P5,000,000 for P5,415,183,
including accrued interest. The bonds are dated January 1, 20x1 and pay annual interest of
14% every December 31. The effective interest rate is 12%.

Requirements:
a. Compute for the initial carrying amount of the bonds.
b. Provide the entry on April 1, 20x1 to record the issuance of the bonds.
c. Compute for the interest expense in 2021.

12. On January 1, 20x1, an entity issues 14%, 3-year, P5,000,000 bonds at a price that
reflects a yield rate of 8%

Requirements: Compute for the issue price of the bonds.

13. On January 1, 20x1, an entity issues bonds with face amount of P5,000,000 for
P5,773,129. The bonds mature on December 31, 20x3 and pay annual interest of 14%. The
effective interest rate is 8%

On December 31, 20x2, after paying the annual interest, the entity retires the bonds at a call
premium of 400,000

Requirements: Provide the entry on December 31, 20x2 to record the retirement of the
bonds.

14. On January 1, 20x1, an entity issues bonds with face amount of P5,000,000 for
P5,200,000. The bonds mature on December 31, 20x3 and pay annual interest o f 12%. The
bonds can be converted into 10,000 ordinary shares of the entity with par value per share of
P200. On January 1, 20x1, the bonds are selling at 101 without the conversion feature. The
effective interest rate on the bonds is 11.59%. All of the bonds are converted into ordinary
shares on January 1, 20x3.

Requirement: Provide the entries:

a. On January 1, 20x1 to record the issuance of the convertible bonds.
b. On January 1, 20x3 to record the conversion of the bonds.
 15. Use the facts in the immediately preceding problem. However, in this case, the entity
retires the bonds on January 1, 20x3 at a call premium of P200,000. Without the conversion
feature, the bonds are selling on this date at 102.

Requirement: Provide the entry on January 1, 20x3 to record the retirement of the bonds.

Use the following information for the next two questions:

On January 1, 20x1, an entity has an outstanding note payable with carrying amount of
P1,000,000

16. On this date, the debtor agrees to receive the equipment with historical cost of
P1,800,000. Accumulated depreciation of P900,000 and fair value of P850,000 in full
settlement of the note payable

Requirement: Compute for the gain or loss on the derecognition of the note payable.

17. On this date, the debtor agrees to receive 10,000 shares of the entity with par value per
share of P10 in full settlement of the note payable. The shares are currently selling at P75
per share.

Requirements:
a. Compute for the gain or loss on the derecognition of the note payable.
b. Provide the entry to record the derecognition of the note payable,

18. An entity has an outstanding bank loan. On December 31, 20x1, the entity agrees to the
following modification to the terms of the loan payable
· The principal is reduced from P2,800,000 to P2,500,000
· The bank promises not to collect the accrued interest of P400,000
· The nominal rate is decreased from 14% to 9%
· The maturity date is extended from December 31, 20x1 to January 1, 20x6

The principal is due in lump sum at maturity date but interest is payable annually at each
year-end. The original effective interest rate is 14%. The prevailing rate on December
31, 20x1 is 12%.

Requirement: Provide the entry to record the modification of the loan.

PROBLEM 3: EXERCISES
1. On January 1, 20x1, an entity issues bonds with face amount of P5,000,000 for
P5,773,129. The bonds mature on December 31, 20x3 and pay annual interest of
14%. The effective interest rate is 8%.

Requirement: Prepare the amortization table for the bonds.

2. On January 1, 20x1, an entity issues bonds with face amount of P8,000,000 for
P8,600,000. The bonds mature on December 31, 20x4 and pay annual interest of
 11% every December 31. The entity incurs transactions costs of P81,645. The
effective interest rate is adjusted for transaction costs is 9%.

Requirement:
a. Compute for the initial carrying amount of the bonds
b. Compute for net discount or a net premium (including the effect of the bond
issue cost) from the issuance on initial recognition.
c. Are the periodic interest payments greater than or less than the periodic
interest expenses?
d. Prepare all the journey entries during the term of the bonds.

3. On September 1, 20x1, have an entity issues bonds with face amount of

8,000,000 for 9,105,022, including accrued interest. The bonds are dated
January 1, 20x1 and pay annual interest of 11% every December 31. The
effective interest rate is 9%.

Requirements:
a. Compute for the initial carrying amount of the bonds.
b. Provide the entry on September 1, 20x1 to record the issuance of the bonds
c. Compute for the interest expense in 20x1.

4. On January 1, 20x1, an entity issues 9%, 3-year, P3,000,000 bonds at a price

that reflects a yield rate of 14%

Requirement: Compute for the discount or premium on the bonds on January 1, 20x1.

5. On March 1, 2002, Pyne Furniture Co. issued P700,000 of 10 percent bonds to

yield 8 percent. Interest is payable semiannually on February 28 and August 31.
The bonds mature in ten years. Pyne Furniture Co. is a calendar-year
corporation.

Requirements:

a. Determine the issue price of the bonds. Show your computations.

b. Prepare an amortization table through the first two interest periods using the
effective-interest method.

c. Prepare the journals entries to record bond-related transactions as of the

following dates:

(a) March 1, 2002

(b) August 31, 2002

 (c) December 31, 2002

(d) February 28, 2003 (assume no revising entries are made)

6. On June 1, 2002, Jefferson Controls, Inc. issued P12,000,000 of 10 percent

bonds to yield 12 percent. Interest is payable semiannually on May 31 and
November 30. The bonds mature in 15 years, Jefferson Controls, Inc. is a
calendar-year corporation

Requirements:

d. Determine the issue price of the bonds. Show your computations.

e. Prepare an amortization table through the first two interest periods using the
effective-interest method.

f. Prepare the journals entries to record bond-related transactions as of the

following dates:

(a) June 1, 2002

(b) November 30, 2002

(c) December 31, 2002

(d) May 31, 2003

7. On January 1, 20x1, an entity issued bonds with a face amount of P4,000,000 for
P3,784,798. The bonds mature on December 31, 20x4 and pay annual interest of
16%. The effective interest rate is 18%.

On December 31, 20x2, after paying the annual interest, the entity retires the bonds
at a call premium of P200,000. The entity is subject to an income tax rate of 30%

Requirement: Provide the entry on December 31, 20x2 to record the retirement of the
bonds.

8. On January 1, 20x1, an entity issues bonds with face amount of P4,000,000 for
P4,100,000. The bonds mature on December 31, 20x4 and pay annual interest of
16%. The bonds can be converted into 10,000 ordinary shares of the entity with
par value per share of P300. On January 1, 20x1, the bonds, without the
conversion feature, are selling at a price which reflects a yield rate of 18%. All of
the bonds are converted into ordinary shares on January 1, 20x3.

Requirement: Provide the entries:

a. On January 1, 20x1 to record the issuance of the convertible bonds.

b. On January 1, 20x3 to record the conversion of the bonds.

 9. Use the facts in the immediately preceding problem. However, in this case, the
entity retires the bonds on January 1, 20x3 at a call premium of P300,000.
Without the conversion feature, the bonds are selling on this date at 105

Requirement: Provide the entry on January 1, 20x3 to record the retirement of the
bonds.

Use the following information for the next two questions:

On January 1, 20x1, an entity has an outstanding note payable with a carrying amount of
P1,200,000.

10. On this date, the debtor agrees to receive equipment with historical cost of
P2,000,000, accumulated depreciation of P900,000 and fair value of P1,000,000
in full settlement of the note payable.

Requirement: Provide the entry to record the derecognition of the note payable.

11. On this date, the debtor agrees to receive 12,000 shares of the entity with par
value per share of P20 in full statement of the note payable. The shares are
currently selling at P110 per share.

Requirements:

a. Compute for the gain or loss on the derecognition of the note payable.

b. Provide the entry to record the derecognition of the note payable.

12. An entity settled an outstanding note with face amount of P3,000,000 and an
unamortized discount of P800,000 by transferring cash of P1,000,000 and land
with fair value of P2,200,000 and carrying amount of P2,100,000

Requirement: Provide the entry to record the derecognition of the note payable.

13. An entity issues 1,000 shares with par value per share of P200 in full
settlement of an outstanding note payable with a carrying amount of P380.000.
The shares are currently selling at P280 per share.

Requirement: Provide the entry to record the derecognition of the note payable.

14. Evanston Manufacturing is faced with possible bankruptcy. Evanston has

P2,000.000 bonds outstanding with an unamortized premium of P68,500.
 Furthermore, Evanston is behind P125,000 in interest payments. To satisfy the
debt, Evanston transfers 60,000 shares of P10 par value stock with a current
market value of P33.75.

Blue Ash Corporation holds P125,000 face value of the Evanston bonds. The
carrying value and interest receivable on Blue Ash's bond holdings are
proportionate to the total issued.

Requirement: Give the entries to record the equity transfer on the books of Evanston
and Blue Ash.

15. On January 1, 20x1, the terms of an entity's existing loan payable is modified
as follows:

● The principal is reduced from P3,000,000 to P2,800,000.

● The lender promises not to collect the accrued interest of P200,000
● The nominal rate decreased from 12% to 8%.
● The maturity date is extended from Dec. 31, 20x1 to Jan. 1, 20x6

The principal is due in lump sum at maturity date but interest is payable annually
at each year-end. The original effective interest rate is 12%. The prevailing rate
on December 31, 20x1 is 9%.

Requirements: Provide the entries on the following dates:

a. January 1, 20x1
b. December 31, 20x1

16. An entity has defaulted in its two annual interest payments on an existing
loan payable. Because of the default, the lender agrees to the following
restructuring of the loan on December 31, 20x1

a. The lender forgoes the payment of the accrued simple interest and any
future interests.
b. The principal will be due in four equal annual payments of P1,000,000 at
each year-end starting on December 31, 20x1. Originally, the P4,000,000
principal amount is due in lump sum on December 31, 20x1.
c. The nominal rate on the original loan is 10%. The current market rate on
December 31, 20x1 is 12%.

Requirements:

a. Provide the entry to record the restructuring of the loan payable

b. Compute for the interest expense in 20x2

PROBLEM 4: CLASSROOM ACTIVITY

1. On January 1, 20x1, RESTRAIN TO CURB Co. issued 1,000, P2,000, 10%, 3-

year bonds for P1,903,927. Principal is due on December 31, 20x3 but interests
are due annually every year-end. The effective interest rate is 12%.
 Requirement: Provide the pertinent entries

2. On January 1, 20x1, INCISE TO CARVE Co. issued 1,000, P2,000, 12%, 3-year
bonds for P2,099,474. Principal is due on December 31, 20x3 but interests are
due annually every year-end. The effective interest rate is 10%.

Requirement: Provide the pertinent entries

PROBLEM 5: MULTIPLE CHOICE - THEORY

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

2. 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.

3. The issue price of a bond is equal to the present value of the future cash flows
for interest and principal when the bond is issued

At face amount At a discount At a premium

a. Yes No Yes
b. Yes No No
c. No Yes Yes
d. Yes Yes Yes

4. Kenwood Co. neglected to amortize the premium on outstanding ten-year

bonds payable. What is the effect of the failure to record premium amortization
on interest expense and bond carrying value, respectively?

a. Understate; understate
b. Understate; overstate
c. Overstate; overstate
d. Overstate; understate

5. On March 1, 1996, Clark Co. issued bonds at a discount. Clark incorrectly

used the straight-line method instead of the effective interest method to amortize
the discount. How were the following amounts, as of December 31, 1997,
affected by the error?

Bond carrying amount Retained earnings

a. Overstated Overstated
b. Understated Understated
c. Overstated Understated
d. Understated Overstated

6. If interest-bearing obligations are issued between interest payment dates, the

accrued interest sold
a. should be included in the carrying amount of the liability as a credit to
'interest expense' or 'interest payable.'
b. should not be included in the carrying amount of the liability but rather
credits to 'interest expense' or 'interest payable.'
c. interest payable is debited
d. interest income is credited

7. The equity component of a compound financial instrument is determined

a. by allocating the issue price to the liability and equity components based
on their relative fair values.
b. by allocating the equity component its fair value.
c. by deducting the fair value of the liability component without the equity
feature from the net proceeds from the issuance of the compound
instrument.
d. none of these

8. Upon conversion of convertible bonds,

a. no gain or loss is recognized
b. any share premium recognized on the conversion feature is transferred
directly to retained earnings
c. any unamorrized discount is derecognzed by a debit
d. a and b

9. Upon retirement of convertible bonds,

a. no gain or loss is recognized
b. gain or loss is recognized as the difference between the retirement price
and the carrying amount of the liability component
c. any share premium recognized on the conversion feature is recognized in
profit or loss
d. gain or loss is recognized as the difference between the retirement price
allocated to the liability component and the carrying amount of the liability
component

10. The share premium recognized on a convertible bond

 a. remains in equity only if the bonds are actually converted
b. reclassified out of equity to profit or loss if the bonds are not converted
c. remains in equity whether the bonds are actually converted or not
d. a and b

11. When the equity feature of a compound instrument is exercised, the related
share premium is
a. transferred directly to retained earnings
b. transferred to profit or loss
c. transferred within equity
d. none of these

12. In an "asset swap," where a liability is settled through the transfer of non cash
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

13. In an "equity swap," where a liability is settled through the issuance of equity
securities, the equity securities issued are measured at
a. the fair value of the equity securities issued
b. the fair value of the liability extinguished
c. the carrying amount of the liability extinguished
d. choice a, if this is determinable, if not, then choice b

14. In an "equity swap," where a liability is settled through the issuance of equity
securities,
a. no gain or loss is recognized
b. any apparent gain or loss is recognized in equity as an addition to shre
premium
c. gain or loss is recognized as the difference between the measurement
amount of the equity securities issued and the carrying amount of the
liability derecognized.
d. a and b
 15. There is substantial modification of a liability if the difference between the
present value of the new liability discounted at the original effective interest rate
and the carrying amount of the old liability is
a. at least 10%
b. more than 10%
c. less than 10%
d. none of these

PROBLEM 6: MULTIPLE CHOICE - COMPUTATIONAL

1. Blue Corp.'s December 31, 1991, balance sheet contained the following items in the long-
term liabilities section:
94% registered debentures, callable in 2002, due in 2007 700,000
9½% collateral trust bonds, convertible into common stock
beginning in 2000, due in 2010 600,000
10% subordinated debentures (P30,000 maturing annually
beginning in 1997) 300,000

What is the total amount of Blue's term bonds?

a. 600,000
b. 700,000
c. 1,000,000
d. 1,300,000

2. Hancock Co.'s December 31, 20x0, balance sheet contained the following items in the long-
term liabilities section:

Unsecured
9.375 registered bonds (P25,000 maturing annually beginning in 20x4) 275,000
11.5% convertible bonds, callable beginning in 20x9, due 2010 125,000

Secured
9.875 guaranty security bonds, due 2x10 250,000
10.0% commodity backed bonds (P50,000 maturing annually beginning
in 20x5 200,000

What are the total amounts of serial bonds and debenture bonds?

Serial bonds Debenture bonds ` Serial bonds Debenture bonds

a. 475,000 400,000 c. 450,000 400,000
b. 475,000 125,000 d. 200,000 650,000

3. During 20x9, Lake Co. issued 3,000 of its 9%, P1,000 face value bonds at 101½. In
connection with the sale of these bonds, Lake paid the following expenses:
Promotion costs P20,000
Engraving and printing 25,000
Underwriters' commissions 200,000

What amount should Lake record as bond issue costs to be amortized over the term of the
bonds?
a. 0
b. 220,000
c. 225,000
d. 245,000

4. On July 1, 20x7, Day Co. received P103,288 for P100,000 face amount, 12% bonds, a price
that yields 10%. Interest expense for the six months ended December 31, 20x7, should be
a. 6,197
b. 6,000
c. 5,164
d. 5,000

5. On January 2, 2001, West Co. issued 9% bonds in the amount of P500,000, which matured
on january 2, 2011. The bonds were issued for P469,500 to yield 10%. Interest is payable
annually on December 31. West uses the effective interest method of amortizing bond discount.
In its June 30, 2001, balance sheet, what amount should West report as bonds payable?
a. 469,500
b. 470,475
c.
d. 471,025
e. 500,000
6. On May 1, 1999, Bolt Corp. issued 11% bonds in the face amount of P1,000,000 that
matured on May 1, 2009. The bonds were issued to yield 19%, resulting in a bond premium of
P62,000. Bolt uses the effective interest method of amortizing bond premium. Interest is
payable semiannually on November 1 and May 1. In its October 31, 1999, balance sheet, what
amount should Bolt report as unamortized bond premium?
a. 62,000
b. 60,100
c. 58,900
d. 58,590

7. On December 31, 20x0, Arnold, Inc., issued P200,000, 8% serial bonds, to be repaid in the
amount of P40,000 each year. Interest is payable annually on December 31. The bonds were
issued to yield 10% a year. The bonds proceeds were P190,280 based on the present values at
December 31, 20x0, of the five annual payments as follows:
 Due date Amounts date Present value
Principal Interest at 12/31/99

12/31/x1 40,000 16,000 50,900

12/31/x2 40,000 12,800 43,610
12/31/x3 40,000 9,600 37,250
12/31/x4 40,000 6,400 31,690
12/31/x5 40,000 3,200 26,830
190,280

Arnold amortizes the bond discount by the effective interest method. In its December 31, 20x1,
balance sheet, at what amount should Arnold report the carrying value of the bonds?
a. 139,380
b. 149,100
c. 150,280
d. 153,308

8. On november 1, 29x4, Mason Corp. issued P800,000 of its 10-year, 8% term bonds dated
October 1, 20x4. The bonds were sold to yield 10% with total proceeds of P700,000 plus
accrued interest. Interest is paid every April 1 and October 1. What amount should Mason report
for interest payable in its December 31, 20x4, balance sheet?
a. 17,500
b. 16,000
c. 11,667
d. 10,667

9. On April 1, 20x9, Hill corp issued 200 of its P1,000 face value bonds at 101 plus accrued
interest. The bonds were dated November 1, 20x8, and bear interest at an annual rate of 9%
payable semiannually on November 1 and May 1. What amount did Hill receive from the bond
issuance?
a. 194,500
b. 200,000
c. 202,000
d. 209,500

10. The following information pertains to Camp Corp's issuance of bonds on July 1, 1998:

Face amount P800,000

Terms 10 years
Stated interest rate 6%
Interest payment dates Annually on July 1
Yield 9%

What should be the issue price for each P1,000 bond?

a. 1,000
b. 864
c. 807
d. 700