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Exam 10: Accounting for Long-Term Liabilities

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Question 1

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On January 1, 2013, Jacob issues $600,000 of 11%, 15-year bonds at a price of 102½. The straight-line method is used to amortize any bond discount or premium. What is the journal entry to record the first interest semi-annual interest payment on June 30, 2013?

A) $\begin{array}{|c|r|r|}\hline \text { Interest Expense } & 33,000 & \\\hline \text { Cash } & & 33,000 \\\hline\end{array}$
B) $\begin{array}{|c|r|r|}\hline \text { Cash } & 33,000 & \\\hline \text { Interest Expense } & & 33,000 \\\hline\end{array}$
C) $\begin{array}{|l|r|l|}\hline \text { Interest Expense } & 32,500 & \\\hline \text { Discount on Bonds Payable } & 500 & \\\hline \text { Cash } & & 33,000 \\\hline\end{array}$
D) $\begin{array}{|l|r|l|}\hline \text { Interest Expense } & 32,500 & \\\hline \text { Premium on Bonds Payable } & 500 & \\\hline \text { Cash } & & 33,000 \\\hline\end{array}$
E) $\begin{array}{|l|r|r|}\hline \text { Interest Expense } & 33,000 & \\\hline \text { Discount on Bonds Payable } & & 500 \\\hline \text { Cash } & & 32,500 \\\hline\end{array}$

F) A) and C)
G) A) and B)

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Question 2

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Which of the following is true regarding the effective interest amortization method?

A) Allocates bond interest expense using a changing interest rate.
B) Allocates bond interest expense using a constant interest rate.
C) Allocates a decreasing amount of interest over the life of a discounted bond.
D) Allocates bond interest expense using the current market rate for each period.
E) Is not allowed by the FASB.

F) None of the above
G) All of the above

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Question 3

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Promissory notes that require the issuer to make a series of payments consisting of both interest and principal are:

Interest payments on bonds are determined by multiplying the par value of the bond by the stated contract rate.

The type of bond that provides the greatest security from theft of loss is the debenture.

Using the debt to equity ratio, which of the following franchises would be assessed as having the riskiest financing structure?

A company purchased two new trucks for a total of $250,000 on January 1, 2013. The company paid $40,000 cash and gave a $210,000, three-year, 8% note for the remaining balance. The note is to be paid in three annual end-of-year payments beginning December 31, 2013. Assume the annual installment payments are to consist of equal amounts of principal plus accrued interest. Prepare a note amortization table using the format below. $\begin{array}{|c|c|c|c|c|c|}\hline \begin{array}{c}\text { Period } \\\text { Ending Date }\end{array} & \begin{array}{c}\text { Beginning } \\\text { Balance }\end{array} & \begin{array}{c}\text { Debit Interest } \\\text { Expense }\end{array} & \begin{array}{c}\text { Debit Notes } \\\text { Payable }\end{array} & \text { Credit Cash } & \begin{array}{c}\text { Ending } \\\text { Balance }\end{array} \\\hline 12 / 31 / 13 & & & & & \\\hline 12 / 31 / 14 & & & & & \\\hline 12 / 31 / 15 & & & & & \\\hline\end{array}$

If an issuer sells a bond at any other date than the interest payment date:

A lease is a contractual agreement between a lessor and a lessee that grants the lessee the right to use the asset for a period of time in return for cash payment(s) to the lessor.

An advantage of bond financing is that issuing bonds does not affect owner control.

Describe the recording procedures for the issuance, retirement, and paying of interest for notes.

On June 1, a company issued $200,000 of 12% bonds at their par value plus accrued interest. The interest on these bonds is payable semiannually on January 1 and July 1. Prepare the issuer's journal entry to record the bond issuance of June 1.

A company purchased two new delivery vans for a total of $250,000 on January 1, 2013. The company paid $40,000 cash and signed a $210,000, three-year, 8% note for the remaining balance. The note is to be paid in three annual end-of-year payments of $81,487 each, with the first payment on December 31, 2013. Each payment includes interest on the unpaid balance plus principal. (1) Prepare a note amortization table using the format below: $\begin{array}{|c|c|c|c|c|c|}\hline \begin{array}{c}\text { Period } \\\text { Ending Date }\end{array} & \begin{array}{c}\text { Beginning } \\\text { Balance }\end{array} & \begin{array}{c}\text { Debit Interest } \\\text { Expense }\end{array} & \begin{array}{c}\text { Debit Notes } \\\text { Payable }\end{array} & \text { Credit Cash } & \begin{array}{c}\text { Ending } \\\text { Balance }\end{array} \\\hline 12 / 31 / 13 & & & & & \\\hline 12 / 31 / 14 & & & & & \\\hline 12 / 31 / 15 & & & & & \\\hline\end{array}$ (2) Prepare the general journal entries to record the purchase of the vans on January 1, 2013 and the second annual installment payment on December 31, 2014.

A corporation plans to invest $1 million in oil exploration. The corporation is considering two plans to raise the money. Under Plan 1, bonds with a contract rate of interest of 6% would be issued. Under Plan 2, additional shares of common stock would be issued at $20 per share. The corporation currently has 300,000 shares of stock outstanding and it expects to earn $700,000 per year before bond interest and income taxes. The net income and return on investment for both plans is shown below: Comment on the relative effects of each alternative, including when one form of financing is preferred to another.

A company has bonds outstanding with a par value of $100,000. The unamortized discount on these bonds is $4,500. The company retired these bonds by buying them on the open market at 97. What is the gain or loss on this retirement?

Match the following definitions to their terms

Explain the present value concept and how it applies to long-term liabilities.

Identify and explain the advantages and disadvantages of bond financing.

A bondholder that owns a $1,000, 10%, 10-year bond has:

A bond traded at 102½ means that: