Sarac, Christeta L

Bu-ucan, Aloha A.
BSA 2

Chapter 3: Bonds Payable and Other Concepts

Problem 1: TRUE OR FALSE
1. Zero-interest bonds sell at a significant discount that provides n investor with a total
interest payoff maturity.
2. Callable bonds may be redeemed prior to maturity at the option of the issuer.
3. The term “junk bonds” is frequently applied at 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 pus the present value 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 payment made
during the life of the bond.
d. The sum of the face amount of the bond and the periodic interest payments.
2. unamortized debt premium should be reported on 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
bonds carrying value, respectively?
a. Understate; understate
b. Understate; overstate
c. Overstate; overstate
d. Overstate; understate
5. bond discount should be presented in the financial statements of the issuer as a (n)
a. Contra liability
b. Adjunct liability
c. Deferred charge
d. Contra asset
6. DESTITUTE LACKING, Inc. issued P500,000, 10% bonds to yield 8%, bond issuance
costs were P10,000. How should DESTITUE 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. Discount 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 bond issue.
c. Recognized as an extraordinary item in the period of extinguishment.
d. Recognized in income from continuing operations 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 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 bond issue costs of P473,767. The effective interest arte
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 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.
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 145 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 bonds.
c. Compute for the interest expense in 20x1.
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%
Requirement: Compute for the issue price of the bonds.
13. On January 1, 20x1, an entity issues bond with face amount of P5,000,000 for
P5,773,129. The bonds mature on December 31, 20x3 and pay annual interest of 14%. Te
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.
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 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:
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 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 t each
year-end. The 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.