chapter 3 reviewer

PROBLEMS
PROBLEM 1: TRUE OR FALSE
__1. Unlike notes payable which involve a single creditor, bonds enable entities to
borrow from several creditors.
__2. The contract between an issuer and its bondholders is called a debenture.
__3. It is the responsibility of the underwriter to monitor the issuer's compliance
with its obligations under a bond issue.
__4. Convertible bonds contain an exercisable option for the issuer.
__5. The market rate tends to go up when the demand for bonds decreases.
__6. When the market rate is higher than the stated rate, the bonds will sell at a
price higher than the bonds' par value.
__7. If the carrying amount of a bond issue exceeds the face amount, the difference
is called discount on bonds payable.
__8. According to the PFRS, discounts or premiums on bonds payable may be amortized
using the straight-line method.
__9. Registered bonds are bonds that can be freely transferred and have a
detachable coupon for each interest payment.
__10. One reason why coupon bonds are seldom issued anymore by corporations is that
there is no readily available record of who actually receives the interest.

PROBLEM 2: MULTIPLE CHOICE - THEORY

1. It is a type of bond that the bondholder can exchange for other securities of
the issuer.
a. debenture bond
b. collateral trust bond
c. convertible bond
d. james bond
2. Transaction costs of issuing bonds
a. are added to the carrying amount of the bonds.
b. are recognized as outright expenses.
c. are amortized as expense over the term of the bonds.
d. a and c.
3. The interest payment dates of a bond issue are April 1and October 1, 20x1. The
bonds were issued on August 31. 20x1. The interest expense for the year ended
December 31, 20x1 would be for:
a. four (4) months
b. six (6) months
c. seven (7) months
d. ten (10) months
4. For a bond issue that sells for less than its par value, the market rate of
interest is
a. Dependent on 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. 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
7. 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 c. Overstate; overstate
b. Understate; overstate d. Overstate; understate
8. On March 1, 1997, 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
9. (On January 2, 20x1, Nast Co. issued 8% bonds with a face amount of PI,OOO,OOO
that mature on January 2, 20x7. The bonds were issued to yield 12%, resulting in a
discount of P150,000. 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, 2027
a. Overstated Understated c. Understated Overstated
b. Overstated No effect d. Understated No effect
10. 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 com without the equity feature from
the issuance price of the compound instrument.
d. none of these

PROBLEM 3: EXERCISES
1. On January 1, 20x1, Sixty Hours Co. issued 1,000, P2,000, 10% bonds P1,903,927.
Principal is due on December 31, 20x3, while interest is due annually every year-
end. The interest rate is 12%.
Requirement: Provide the journal entries over the life of the bonds.
2. On January 1, 20x1, Faith Co. issued 1,000, P2,000, 120% bonds for P2,206,168.
Principal is due on December 31, 20x3, while interest is due annually every year-
end. Faith Co. incurred transaction costs of P106,694 on the issuance. The
effective interest rates are 8% before adjustment for transaction costs and 10%
after adjustment for transaction costs.
Requirement: Provide the journal entries over the life of the bonds.
3. On January 1, 20x1, Hope Co. issued 5-year, 12%, P2,000,000 bonds for
P2,151,632. Principal is due at maturity, while interest is due annually every
year-end. The effective interest rate is 10%. On July 1, 20x3, Hope Co. retired all
the bonds at 102. The retirement price includes payment for the accrued interest.
Requirement: Provide the entries on July 1, 20x3.
4. On January 1, 20x1, Patience Co. issued 10%, 3-year, P2,000,000 convertible
bonds at 105. Each P1,000 bond is convertible into 8 shares with par value per
share of P100. Principal is due on December 31, 20x3, while interest is due
annually every year-end. On issuance date, the bonds were selling at a yield to
maturity market rate of 12% without the conversion option. All the bonds were
converted into equity on December 31, 20x2. Patience Co. incurred stock issuance
costs of P20,000.
Requirement: Provide all the journal entries in 20x1 and 20x2.
5. On January 1, 20x1, Kindness Co. issued 3-year, 10%, P2,000,000 convertible
bonds for P2,200,000. Principal is due at maturity but interest is payable every
year-end. The bonds are convertible into 6,000 ordinary shares with par value per
share of P200. On issuance date, the prevailing market rate of interest for similar
debt without a conversion feature was 12%. On December 31, 20x2, Kindness Co.
retired all the bonds for P2,000,000. On retirement date, the current rate for
similar debt instrument without a conversion feature was 11%.
Requirement: Provide all the entries in 20x1 and 20x2.

PROBLEM 4: MULTIPLE CHOICE - COMPUTATIONAL

1. Blue Corp.'s December 31, 1991, balance sheet contained the following items in
the long-term liabilities section:
9 3/4% registered debentures, callable in 2002, due in 2007 700,000
9 1/2% 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. On January 2, 2001, West Co. issued 9% bonds in the amount of P500,000, which
mature 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. 471,025
d. 500,000

3. On January 1, 20x1, Yoga Co. issued 1,000, P4,000 face amount bonds for
P3,807,852. The bonds mature on December 31, 20x3. Interest of 10% is due annually
every year-end. The effective interest rate is 12%. How much is the unamortized
discount on bonds payable on December 31, 20x1?
a. 147,908
b. 135,206
c. 134,987
d. 143,134

4. On January 1, 20x1, Silent Co. issued 1,000 bonds with face amount of P4,000
each for a total of P3,807,852. Silent Co. paid transaction costs of P179,316 on
the issuance. The bonds mature on December 31, 20x3 but 10% interest is due every
year-end. The effective interest rate adjusted for the transaction costs is 14%.
How much is the carrying amount of the bonds on December 31, 20x1?
a. 3,288,776
b. 3,391,580
c. 3,401,832
d. 3,736 ,531

5. 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

6. Tuck Co. plans on issuing three-year, 12% term bonds with face amount of
P2,000,000. If the current rate on issuance date is 10%, the estimated issue price
of the bonds would be
a. 2,099,474.
b. 2,123,649
c. 2,230,713.
d. 1,979,365

7. On June 30, 20x9, King Co. had outstanding 9%, P5,000,000 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 P30,000 and P50,000, 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

8. 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 bond proceeds were P190,280
based on the present values at December 31, 20x0, of the five annual payments as
follows:
Due date Amounts due Present value at
Principal Interest 12/31/x0
12/31/x1 40,000 16,000 50,9000
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

9. On January 1, 20x1, NESCIENCE IGNORANCE co. issued 10%, P6,000,000 zero-coupon

bonds at a price that reflects a yield to maturity rate of 18%. Both the principal
and accrued interests are due on December 31, 20x3. What amounts are reported in
NESCIENCE CO.'s December 31, financial statements for the following?
Bonds payable Interest payable Bonds payable Interest payable
a. 5,135,421 600,000 c. 5,735,421 600,000
b. 5,268,944 600,000 d. 5,735,421 0

10. Ray Corp. issued bonds with a face amount of P200,000. Each P1,000 bond
contained detachable stock warrants for 100 shares of Ray's common stock. Total
proceeds from the issue amounted to P240,000. The fair value of each warrant was
P2,196,000. The bonds were issued at a discount of
a. 0
b. 678
c. 4,000
d. 33,898

11. On July 1, 2003, after recording interest and amortization, York Co. converted
P1,000,000 of its 12% convertible bonds into 50,000 shares of P1 par value ordinary
share. On the conversion date the carrying amount of the bonds was P1,300,000, the
fair value of the bonds was P1,400,000, and York's ordinary share was publicly
trading at P30 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

12. On January 1, 20x1, Melancholic Co. issued 10%, convertible bonds for
P2,200,000. The bonds, which are due on December 31, 20x3, are convertible into
10,000 ordinary shares with par value of P100. The annual interest payments are due
at each year-end. The prevailing market rate of interest for similar debt without
conversion feature on January 1, 20x1 was 12%. On December 31, 20x2, half of the
bonds were retired for P1,000,000. The prevailing interest rate for similar debt
without conversion feature on December 31, 20x2 was 11%. How much are the (1) gain
(loss) on the retirement and (2) net amount of “share premium – conversion feature”
reclassified within equity on December 31, 20x2?
a. 9,724; 152,760 c. (8,849); 139,028
b. (9,724); 152,670 d. 8,849; 139,208

13. During 20x4 Peterson Company experienced financial difficulties and is likely
to default on a P500,000, 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 P75,000 for 20X4 for P50,000 cash and marketable securities with
carrying amount of P375,000. Peterson's acquisition cost of the securities is
P385,000. 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

14. Wood Corp., a debtor undergoing financial difficulties granted an equity

interest to a creditor in full settlement of a P28,000 debt owed to the creditor.
At the date of this transaction, the equity interest had a fair value of P25,000
and par value of P20,000. What amount should Wood recognize as gain on
restructuring of debt?
a. 0
b. 3,000
c. 5,000
d. 8,000

15. In 20X2, May Corp. acquired land by paying P75,000 down and signing a note with
a maturity value of P1,000,000. On the note's due date, December 31, 20X7, May owed
P40,000 of accrued interest and P1,000,000 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 P40,000 of interest due on December 31, 20X7, was forgiven.
• The principal of the note was reduced from P1,000,000 to P950,000 and the
maturity date extended 1 year to December 31, 20X8.
• May would be required to make one interest payment totaling P30,000 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

PROBLEM 5: CLASSROOM ACTIVITY

You are the accountant of B-Cull co. on July 1, 20x1, company issued 1,000 pieces
of the document shown below with serial numbers SR/213-2 (shown below) to SR/213-
1001 (not shown to save space). The total issue price is P922,782, net of
transaction costs.
Requirements:
a. Compute for the effective interest rate on the bond issue
b. Prepare the amortization table (you may round-off centavos)
c. Prepare the journal entries for 20x1 only.

PROBLEM 6: FOR CLASSROOM DISCUSSION

Bonds issued at a discount — with Transaction costs
1. 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 bond issue costs of P473,767. The interest
rate adjusted for bond issue costs is 16%.
Requirements:
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 journal entries during the term of the bonds.

Issuance of bonds between interest payment dates

2. 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 20x1.

Issue price of bonds

3. On January 1, 20x1, Vale Co. issues 14%, 3-year, P5,000,000 bonds at a price
that reflects a yield rate of 8%.
Requirement: Compute for the issue price of the bonds.

Retirement of bonds prior to maturity

4. On January for 1, 20x1, an entity issues bonds with face amount of P5,000,000
for P5,773,129. The bonds mature on face 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 P400,000.
Requirement: Provide the entry on December 31, 20x2 to record the retirement of the
bonds.

Convertible bonds — Conversion

5. 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 of 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 to record the following:
a. issuance of the convertible bonds.
b. conversion of the bonds.

Convertible bonds — Retirement

6. 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 to record the retirement of the bonds.

Asset swap
7. On January 1, 20x1, an entity transfers a piece of equipment with historical
cost of P1,800,000, accumulated depreciation of P900,000 and fair value of P850,000
as full settlement of a note payable with a carrying amount of P1.000.000. How much
is the gain or loss on the derecognition of the note?

Equity swap
8. On January 1, 20x1, an entity issues 10,000 of its own shares with par value per
share of P10 and fair value per share of P75 as full settlement of a note payable
with a carrying amount of P600,000. How much is the gain or loss on the
derecognition of the note?

Modification of terms
9. On December 31, 20x1, an entity enters into a restructuring agreement to modify
the terms of its existing loan as follows:
-The principal is reduced from P2,800,000 to P2,500,000.
-The lender waived 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