University of Maryland

ECON 103

True/False Questions

1)The specific provisions of a bond issue are described in a document called a bond indenture.

2. Bonds will sell for a premium when the market rate of interest exceeds their stated rate.

3. Periodic interest expense is the stated interest rate times the amount of debt outstanding during the period.

4. The initial selling price of bonds represents the sum of all the future cash outflows required by the obligation.

5. Amortization of discount on bonds payable results in interest expense that is less than the actual cash outflow.

6. Premium on bonds payable is a contra liability account.

7. The carrying value of zero-coupon bonds increases by the periodic amount of interest recognized.

8. Paid-in capital is increased when bonds payable are issued with detachable stock purchase warrants.

9. An implicit or imputed rate of interest must be used when long term notes are issued at a stated rate of interest that is materially different than the market rate of interest.

10. The interest on an installment note decreases with each periodic payment.

Matching Pair Questions

Use the following to answer questions 11-15:

11-15. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

1. Bond indenture
2. Call feature
3. Gain on extinguishment
4. Implicit rate of interest
5. Interest expense
6. Interest fund
7. Loss on extinguishment
8. Mortgage bond
1. Sinking fund
10. Subordinated debenture

Phrases:

11.            Used when the rate is not stated or is materially different from the market rate.
12.            Used by a trustee to repurchase bonds in the open market.
13.            Conceptually equal to effective rate times balance.
14.            Secured by real property.
15.            Promises made to bondholders.

Use the following to answer questions 16-20:

16-20. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

1. Bond indenture
2. Call feature
3. Default risk
4. Gain on extinguishment
5. Implicit rate of interest
6. Interest expense
7. Loss on extinguishment
8. Mortgage bond
1. Stock warrant
10. Subordinated debt

Phrases:

16.            Protects debt issuer if rates fall.
17.            The amount by which the reacquisition price of debt exceeds carrying value
18.            Possibility of debt dishonor.
19.            Other debts have superior claims.
20.            Right of an investor to purchase a specific number shares at a fixed price.

Use the following to answer questions 21-25:

21-25. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

1. Convertible bonds
2. Coupon bonds
3. Debenture bond
4. Debt service ratio
5. Debt to equity ratio
6. Default to interest ratio
7. Installment notes
8. Nameless notes
1. Serial bonds
10. Times interest earned ratio

Phrases:

21.            No specific assets pledged.
22.            Name of owner not registered.
23.            Measures default risk.
24.            Measures ability to service debt.
25.            May become stock.

Use the following to answer questions 26-30:

26-30. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

1. Convertible bonds
2. Coupon bonds
3. Debenture bond
4. Debt issue costs
5. Discount on bonds
6. Installment notes
7. Maturity bonds
8. Premium on bonds
1. Profession notes
10. Serial bonds

Phrases:

26.            Market rate less than stated rate.
27.            Market rate higher than stated rate.
28.            No maturity payment.
29.            Legal, accounting, printing.
30.            Many separate maturity dates.

Use the following to answer questions 31-35:

31-35. Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term by placing the letter designating the best term in the space provided by the phrase.

Terms:

1. Bond price
2. Book value method
3. Convertible stocks
4. Effective interest method
5. Induced conversion
6. Market value method
7. Straight-line method
8. Troubled debt restructuring
1. Warrants
10. Zero-coupon bonds

Phrases:

31.            Requires(s) no cash outflow before maturity.
32.            Often traded separately from associated bonds.
33.            A practical expediency when not misleading.
34.            Additional consideration is recorded as an expense.
35.            No gain or loss recorded when convertible bond option is exercised.

Multiple Choice Questions

36. In each succeeding payment on an installment note:
    1. The amount of interest paid increases.
    2. The amount of principal reduction increases.
    3. The amount of interest paid is unchanged.
    4. The amounts paid for both interest and principal increase proportionately.

37. Interest expense is:
    1. The effective interest rate times the amount of the debt outstanding during the interest period.
    2. The stated interest rate times the amount of the debt outstanding during the interest period.
    3. The effective interest rate times the face amount of the debt.
    4. The stated interest rate times the face amount of the debt.

38. Ordinarily, the proceeds from the sale of a bond issue will be equal to:
    1. The face amount of the bond.
    2. The total of the face amount plus all interest payments.
    3. The present value of the face amount plus the present value of the stream of interest payments.
    4. The face amount of the bond plus the present value of the stream of interest payments.

39. The interest rate that is printed on the bond certificate always is the same as each of the following except one, which is:
    1. Stated rate.
    2. Contract rate.
    3. Nominal rate.
    4. Effective rate.

40. In theory (disregarding other marketplace variables), bonds should sell for their:
    1. Maturity value.
    2. Face value.
    3. Present value.
    4. Statistical expected value

41. Most corporate bonds are:
    1. Mortgage bonds.
    2. Debenture bonds.
    3. Secured bonds.
    4. Collateral bonds.

42. The method used to pay interest depends on whether the bonds are:
    1. Registered or coupon.
    2. Mortgaged or unmortgaged.
    3. Indentured or debentured.
    4. Callable or redeemable.

43. To evaluate the risk and quality of an individual bond issue, savvy investors rely heavily on:
    1. Bond ratings provided by financial investment services such as Moody's.
    2. Newspaper articles.
    3. Bond interest payments.
    4. The company's audit report.

44. Griggs Co. failed to amortize the premium on an outstanding five-year bond issue. What is the resulting effect on interest expense and the bond carrying value, respectively?
    1. Understated, understated.
    2. Understated, overstated.
    3. Overstated, understated.
    4. Overstated, overstated.

45. The rate of interest expense that is actually incurred on a bond payable is called the:
    1. Face rate.
    2. Contract rate.
    3. Effective rate.
    4. Stated rate.

46. Which of the following indicates the margin of safety provided to creditors?
    1. Rate of return on shareholders' equity.
    2. Times interest earned ratio.
    3. Gross margin.
    4. Debt to equity ratio.

47. A $500,000 bond issue sold for 98.Therefore, the bonds:
    1. Sold at a discount because the stated rate of interest was lower than the effective rate.
    2. Sold for the $500,000 face amount less $10,000 of accrued interest.
    3. Sold at a premium because the stated rate of interest was higher than the yield rate.
    4. Sold at a discount because the effective interest rate was lower than the face rate.

48. Bond X and bond Y are both issued by the same company. Each of the bonds has a maturity value of $100,000 and they each pay interest at 8%. The current market rate of interest is 8%. Bond X matures in 7 years while bond Y matures in 10 years. Which of the following is correct?
    1. Both bonds will sell for the same amount.
    2. Both bonds will sell for more than $100,000.
    3. Bond X will sell for more than bond Y.
    4. Bond Y will sell for more than bond X.

49. Bond X and bond Y are both issued by the same company. Each of the bonds has a maturity value of $100,000 and each pay mature in 10 years. Bond X pays 8% interest while bond Y pays 9% interest. The current market rate of interest is 8%. Which of the following is correct?
    1. Both bonds will sell for the same amount.
    2. Both X will sell for more than bond Y.
    3. Both Y will sell for more than bond X.
    4. Both bonds will sell at a discount.

50. Straight-line amortization of bond discount or premium:
    1. Can be used for amortization of discount or premium in all cases and circumstances.
    2. Provides the same amount of interest expense each period as does the effective interest method.
    3. Is appropriate for deep discount bonds.
    4. Provides the same total amount of interest expense over the life of the bond issue as does the effective interest method.

51. Bonds payable should be reported as a long-term liability on the balance sheet of the issuing corporation at:
    1. Face value price less any unamortized discount or plus any unamortized premium.
    2. Current bond market price.
    3. Face value less any unamortized premium or plus any unamortized discount.
    4. Face value less accrued interest since the last interest payment date.

52. The unamortized balance of discount on bonds payable is reported on the balance sheet as:
    1. A prepaid expense.
    2. An expense account.
    3. A current liability.
    4. A contra-liability.

53. When the interest payment dates are March 1 and September 1, and the notes are issued on July 1, the amount of interest expense to be accrued at December 31 of the year of issue would:
    1. Not be required.
    2. Be for six months.
    3. Be for four months.
    4. Be for ten months.

54. When the interest payment dates are March 1 and September 1, and the bonds are issued on July 1, the amount of interest expense reported on the December 31 income statement for the year of issue would be for:
    1. Six months.
    2. Four months.
    3. Ten months.
    4. Twelve months.

55. How would the carrying value of bonds payable be affected by the amortization of each of the following?

Premium                    Discount

1. 1. No effect                   No effect
   2. No effect                    Increase
   3. Increase                    Decrease
   4. Decrease                    Increase

56. For the issuer of 20-year bonds, the amount of amortization using the effective interest method would decrease each year if the bonds were sold at a:

Discount                    Premium

1. 1. No                                No
   2. No                               Yes
   3. Yes                               Yes
   4. Yes                                No

57. For a bond issue that sells for more than the bond face amount, the effective interest rate is:
    1. The rate printed on the face of the bond.
    2. The Wall Street Journal prime rate.
    3. More than the rate stated on the face of the bond.
    4. Less than the rate stated on the face of the bond.

58. When outstanding bonds are converted into common stock, under either the book value method or the market method, the same amount would be debited to:

Bonds Payable        Bond Premium

1. 1. Yes                               Yes
   2. No                               Yes
   3. No                                No
   4. Yes                                No

59. Eagle Company issued ten-year bonds at 96 during the current year. In the year-end financial statements, the discount should be:
    1. Deducted from bonds payable.
    2. Added to bonds payable.
    3. Included as an expense in the year of issue.
    4. Reported as a deferred charge.

60. Liberty Company issued ten-year bonds at 105 during the current year. In the year-end financial statements, the premium should be:
    1. Reported as an intangible asset.
    2. Included in revenue for the year of sale.
    3. Deducted from bonds payable.
    4. Added to bonds payable.

61. When bonds are sold at a premium and the effective interest method is used for amortization, at each subsequent interest payment date, the cash paid is:
    1. Less than the effective interest.
    2. Equal to the effective interest.
    3. Greater than the effective interest.
    4. More than if the bonds had been sold at a discount.

62. When bonds are sold at a discount and the effective interest method is used for amortization, at each subsequent interest payment date, the cash paid is:
    1. More than the effective interest.
    2. Less than the effective interest.
    3. Equal to the effective interest.
    4. More than if the bonds had been sold at a premium.

63. When bonds are sold at a discount and the effective interest method is used for amortization, at each interest payment date, the interest expense:
    1. Increases.
    2. Decreases.
    3. Remains the same.
    4. Is equal to the change in book value.

64. When bonds are sold at a premium and the effective interest method is used for amortization, at each interest payment date, the interest expense:
    1. Remains constant.
    2. Is equal to the change in book value.
    3. Increases.
    4. Decreases.

65. When bonds are sold at a discount, if the annual straight-line amortization amount is compared to the annual effective interest amortization amount over the life of the bond issue, one would find that the annual amount of the straight-line amortization of discount is:
    1. Higher than the effective interest amount every year.
    2. Higher than the effective interest amount in the early years and less than the effective interest amount in the later years.
    3. Less than the effective interest amount in the early years and more than the effective interest amount in the later years.
    4. Less than the effective interest amount every year.

66. When bonds are sold at a premium, if the annual straight-line amortization amount is compared to the annual effective interest amortization amount over the life of the bond issue, one would find that the annual amount of the straight-line amortization of premium is:
    1. Higher than the effective interest amount in the early years and less than the effective interest amount in the later years.
    2. Less than the effective interest amount in the early years and more than the effective interest amount in the later years.
    3. Higher than the effective interest amount every year.
    4. Less than the effective interest amount every year.

67. When bonds are retired prior to their maturity date:
    1. GAAP has been violated.
    2. The issuing company probably will report an ordinary gain or loss.
    3. The issuing company probably will report an extraordinary gain or loss.
    4. The issuing company will report a non-operating gain or loss.

68. When bonds include detachable warrants, what is the appropriate accounting for the cash proceeds from the bond issue?
    1. The proceeds from the bond issue are allocated between the bonds and the warrants on the basis of their relative market values.
    2. The proceeds from the bond issue are allocated between the bonds and the warrants on the basis of their relative face values.
    3. A nominal amount is allocated to the warrants.
    4. All of the proceeds are allocated to the bonds.

69. When a long-term note is given in exchange for equipment, the amount considered as paid for the machine is:
    1. The invoice price.
    2. The wholesale price.
    3. The present value of cash outflows discounted at the stated rate.
    4. The present value of the note payments discounted at the market rate.

70. When an equipment dealer receives a long-term note in exchange for equipment, the present value of the future cash flows received on the notes:
    1. Is treated as a current liability at the exchange date.
    2. Is recorded as interest revenue at the exchange date.
    3. Is recorded as interest receivable at the exchange date.
    4. Is credited to sales revenue at the exchange date.

71. An amortization schedule for a bond issued at a premium:
    1. Summarizes the amortization of the premium, a contra-asset account with a credit balance.
    2. Is contained in the balance sheet.
    3. Is a schedule that reflects the changes in the debt over its term to maturity.
    4. All of the above are correct.

  Use the following to answer questions 72-75:

Lopez Plastics Co. (LPC) issued callable bonds on January 1, 2006. LPC's accountant has projected the following amortization schedule from issuance until maturity:

72. LPC issued the bonds:
    1. At par.
    2. At a premium.
    3. At a discount.
    4. Cannot be determined from the given information.

73. What is the annual stated interest rate on the bonds? A) 3.5%

2. 6%
3. 7%
4. None of the above is correct.

74. What is the effective interest rate on the bonds?
    1. 3%

B) 3.5%

3. 6%
4. 7%

75. LPC calls the bonds at 103 immediately after the interest payment on 12/31/07 and retires them. What gain or loss, if any, would LPC record on this date?
    1. No gain or loss
    2. $3,717 gain
    3. $6,000 loss
    4. $2,283 loss

Use the following to answer questions 76-80:

Auerbach Inc. issued 4% bonds on October 1, 2006. The bonds have a maturity date of September 30, 2016 and a face value of $300 million. The bonds pay interest each March 31 and September 30, starting on 3/31/07 and finishing at maturity. The effective interest rate established by the market is 6% annually at the date of issue.

Select the letter for the best answer to each of the following:

76. Auerbach issued the bonds:
    1. At par.
    2. At a premium.
    3. At a discount.
    4. Cannot be determined from the given information.

77. How much cash interest does Auerbach pay on 3/31/07?
    1. $6.0 million
    2. $12.0 million
    3. $9.0 million
    4. $18.0 million

78. How much did Auerbach receive from the bond issue on 10/1/2006, rounded up to the nearest thousand?

A) $255,369,000

B)  $ 93,540,000

C) $162,360,000

D) $166,104,000

79. Assuming that Auerbach issued the bonds for $255,369,000, what interest expense would it recognize on its 2006 income statement?
    1. $0

B) $3,830,535

C) $5,107,380

D) $7,661,070

80. Assuming that Auerbach issued the bonds for $255,369,000, what would the company report for its net bond liability balance after its first interest payment on 3/31/07, rounded up to the nearest thousand?

A) $102,296,000

B) $102,796,000

C) $257,030,070

D) Cannot be determined from the given information.

81. During the year, Hamlet Inc. paid $20,000 to have bond certificates printed and engraved, paid

$100,000 in legal fees, paid $10,000 to a CPA for registration information, and paid $200,000 to an underwriter as a commission. What is the amount of bond issue costs?

A) $430,000.

B)   $300,000.

C)   $120,000.

D) $20,000.

82. On September 1, 2006, Sam's Shoe Co. issued $350,000 of 8% bonds. The bonds pay interest semiannually on January 1 and July 1 of each year. The bonds were sold at the face amount. How much cash did Sam's receive upon sale of the bonds?

A) $378,000.

B)   $364,000.

C) $354,667

D) $350,000.

83. A bond issue with a face amount of $500,000 bears interest at the rate of 10%. The current market rate of interest is 11%. These bonds will sell at a price that is:
    1. Equal to $500,000.
    2. More than $500,000.
    3. Less than $500,000.
    4. The answer cannot be determined from the information provided.

84. On January 1, 2006, Zebra Corporation issued 1,000 of its 8%, $1,000 bonds at 98. Interest is payable semiannually on January 1 and July 1. The bonds mature on January 1, 2016. Zebra paid $50,000 in bond issue costs. Zebra uses the straight-line amortization method. What is the bond carrying value reported on the December 31, 2006, balance sheet?

A) $1,045,000.

B) $1,040,000.

C)   $987,000.

D) $982,000.

85. On January 1, 2006, Solo Inc. issued 1,000 of its 8%, $1,000 bonds at 98. Interest is payable semiannually on January 1 and July 1. The bonds mature on January 1, 2016. Solo paid

$50,000 in bond issue costs. Solo uses straight-line amortization. The amount of interest expense for the year is:

A) $80,000.

B)   $82,000.

C)   $78,000.

D) $89,000.

86. On January 1, 2006, an investor paid $291,000 for bonds with a face amount of $300,000. The contract rate of interest is 8% while the current market rate of interest is 10%. Using the effective interest method, how much interest income is recognized by the investor in 2006 (assume annual interest payments and amortization)?

A) $23,280.

B)   $29,100.

C)   $24,000.

D) $30,000.

87. On January 1, 2006, an investor paid $291,000 for bonds with a face amount of $300,000. The contract rate of interest is 8% while the current market rate of interest is 10%. Using the effective interest method, how much interest income is recognized by the investor in 2007 (assume annual interest payments and amortization)?

A) $23,280.

B)   $25,140.

C)   $29,100.

D) $29,610.

88. Cramer Company sold 5-year, 8% bonds on October 1, 2006. The face amount of the bonds was $100,000, while the issue price was $102,000. Interest is payable on April 1 of each year. The fiscal year of Cramer Company ends on December 31. How much interest expense will Cramer Company report on its December 31, 2006, income statement (assume straight-line amortization)?

A) $ 2,000.

B)   $ 1,900.

C)   $ 1,778.

D) $ 2,040.

89. MSG Corporation has $100,000 of 10-year, 6% bonds outstanding on December 31, 2005. The bonds have 3 years remaining to maturity. The unamortized premium remaining on these bonds was $6,000. MSG uses straight-line amortization. On May 1, 2006, $10,000 of the bonds were retired at 112. How much, and what type of gain or loss, results from this retirement?
    1. $667 ordinary loss.
    2. $667 extraordinary loss.
    3. $667 ordinary gain.
    4. $667 extraordinary gain.

90. Nickel Inc. owns $100,000 of 10-year, 6% bonds as an investment on December 31, 2005. The bonds have 3 years remaining to maturity. The unamortized premium remaining on these bonds was $6,000. Nickel uses straight-line amortization. On May 1, 2006, $10,000 of the bonds were redeemed at 110. How much, and what type of gain or loss, results from this redemption?
    1. $467 ordinary gain.
    2. $467 extraordinary gain.
    3. $467 extraordinary loss.
    4. $467 ordinary loss.

91. On February 1, 2005, Pat Weaver Inc. (PWI) issued 10%, $1,000,000 bonds for $1,116,000. PWI retired all of these bonds on January 1, 2006, at 102. Unamortized bond premium on that date was $92,800. How much gain or loss should be recognized on this bond retirement?
    1. $0 gain.

B) $111,800 gain.

C)  $72,800 gain.

D) $102,800 gain.

Use the following to answer questions 92-96:

Prescott Corporation issued ten thousand $1,000 bonds on January 1, 2006. They have a ten-year term and pay interest semiannually. This is the partial bond amortization schedule for the bonds.

92. What is the stated annual rate of interest on the bonds? A) 3%.

B)   4%.

C)   6%.

D) 8%.

93. What is the effective annual rate of interest on the bonds? A) 3%.

B)   4%.

C)   6%.

D) 8%.

94. What is the interest expense on the bonds in 2007? A) $800,000.

B)   $680,759.

C)   $342,961.

D) $119,241.

95. What is the carrying value of the bonds as of December 31, 2007? A) $11,432,379.

B) $11,375,350.

C) $11,316,611.

D) $11,256,109.

96. What would be the total interest expense recognized for the bond issue over their full term? A) $6,512,253.

B) $8,000,000.

C) $11,256,109.

D) $11,487,747.

Use the following to answer questions 97-100:

Discount-Mart issued ten thousand $1,000 bonds on January 1, 2006. They have a ten-year term and pay interest semiannually. This is the partial bond amortization schedule for the bonds.