CHAPTER 14

LONG-TERM LIABILITIES

TRUE FALSE—Conceptual

1. Companies usually make bond interest payments semiannually, although the interest rate
is generally expressed as an annual rate. T

2. A mortgage bond is referred to as a debenture bond. F

3. Bond issues that mature in installments are called serial bonds. T

4. If the market rate is greater than the coupon rate, bonds will be sold at a premium. F

5. The interest rate written in the terms of the bond indenture is called the effective yield or
market rate. F

6. The stated rate is the same as the coupon rate. T

7. Amortization of a premium increases bond interest expense, while amortization of a

discount decreases bond interest expense. F

8. A bond may only be issued on an interest payment date. F

9. The cash paid for interest will always be greater than interest expense when using
effective-interest amortization for a bond. F

10. Bond issue costs are capitalized as a deferred charge and amortized to expense over the
life of the bond issue. T

11. The replacement of an existing bond issue with a new one is called refunding. T

12. If a long-term note payable has a stated interest rate, that rate should be considered to be
the effective rate. F

13. The implicit interest rate is the rate that equates the cash received with the amounts
received in the future. T

14. An unrealized holding gain or loss is the net change in the fair value of the liability from
one period to another, exclusive of interest expense recognized but not recorded. T

15. Off-balance-sheet financing is an attempt to borrow monies in such a way to minimize the
reporting of debt on the balance sheet. T

16. The debt to total assets ratio will go up if an equal amount of assets and liabilities are
added to the balance sheet. T

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 17. If a company plans to retire long-term debt from a bond retirement fund, it should report
the debt as current. F

MULTIPLE CHOICE—Conceptual

22. The covenants and other terms of the agreement between the issuer of bonds and the
lender are set forth in the
a. bond indenture.
b. bond debenture.
c. registered bond.
d. bond coupon.

24. Bonds for which the owners' names are not registered with the issuing corporation are
called
a. bearer bonds.
b. term bonds.
c. debenture bonds.
d. secured bonds.

27. The interest rate written in the terms of the bond indenture is known as the
a. coupon rate.
b. nominal rate.
c. stated rate.
d. coupon rate, nominal rate, or stated rate.

31. Reich, Inc. issued bonds with a maturity amount of $200,000 and a maturity ten years
from date of issue. If the bonds were issued at a premium, this indicates that
a. the effective yield or market rate of interest exceeded the stated (nominal) rate.
b. the nominal rate of interest exceeded the market rate.
c. the market and nominal rates coincided.
d. no necessary relationship exists between the two rates.

33. Under the effective-interest method of bond discount or premium amortization, the periodic
interest expense is equal to
a. the stated (nominal) rate of interest multiplied by the face value of the bonds.
b. the market rate of interest multiplied by the face value of the bonds.
c. the stated rate multiplied by the beginning-of-period carrying amount of the bonds.
d. the market rate multiplied by the beginning-of-period carrying amount of the bonds.

37. Theoretically, the costs of issuing bonds could be

a. expensed when incurred.
b. reported as a reduction of the bond liability.
c. debited to a deferred charge account and amortized over the life of the bonds.
d. any of these.

40. An early extinguishment of bonds payable, which were originally issued at a premium, is
made by purchase of the bonds between interest dates. At the time of reacquisition
a. any costs of issuing the bonds must be amortized up to the purchase date.
b. the premium must be amortized up to the purchase date.
c. interest must be accrued from the last interest date to the purchase date.

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 d. all of these.

47. If a company chooses the fair value option, a decrease in the fair value of the liability is
recorded by crediting
a. Bonds Payable.
b. Gain on Restructuring of Debt.
c. Unrealized Holding Gain/Loss-Income.
d. None of these.

48. Which of the following is an example of "off-balance-sheet financing"?

1. Non-consolidated subsidiary.
2. Special purpose entity.
3. Operating leases.
a. 1
b. 2
c. 3
d. All of these are examples of "off-balance-sheet financing."

50. Long-term debt that matures within one year and is to be converted into stock should be
reported
a. as a current liability.
b. in a special section between liabilities and stockholders’ equity.
c. as noncurrent.

d. as noncurrent and accompanied with a note explaining the method to be used in its
liquidation.

53. The times interest earned ratio is computed by dividing

a. net income by interest expense.
b. income before taxes by interest expense.
c. income before income taxes and interest expense by interest expense.
d. net income and interest expense by interest expense.

MULTIPLE CHOICE—Computational
Use the following information for questions 60 through 62:
On January 1, 2012, Ellison Co. issued eight-year bonds with a face value of $2,000,000 and a
stated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were
sold to yield 8%. Table values are:
Present value of 1 for 8 periods at 6% ...................................................627
Present value of 1 for 8 periods at 8% ...................................................540
Present value of 1 for 16 periods at 3% .................................................623
Present value of 1 for 16 periods at 4% .................................................534
Present value of annuity for 8 periods at 6% ..................................... 6.210
Present value of annuity for 8 periods at 8% ..................................... 5.747
Present value of annuity for 16 periods at 3% ................................. 12.561
Present value of annuity for 16 periods at 4% ................................. 11.652

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60.................................................................The present value of the principal is
a. $1,068,000.
b. $1,080,000.
c. $1,246,000.
d. $1,254,000.

61. The present value of the interest is

a. $689,640.
b. $699,120.
c. $745,200.
d. $753,660.

62. The issue price of the bonds is

a. $1,767,120.
b. $1,769,640.
c. $1,779,120.
d. $1,999,200.

65. Everhart Company issues $15,000,000, 6%, 5-year bonds dated January 1, 2012 on
January 1, 2012. The bonds pays interest semiannually on June 30 and December 31.
The bonds are issued to yield 5%. What are the proceeds from the bond issue?
2.5% 3.0% 5.0% 6.0%
Present value of a single sum for 5 periods .88385 .86261 .78353 .74726
Present value of a single sum for 10 periods .78120 .74409 .61391 .55839
Present value of an annuity for 5 periods 4.64583 4.57971 4.32948 4.21236
Present value of an annuity for 10 periods 8.75206 8.53020 7.72173 7.36009

a. $15,000,000
b. $15,649,482
c. $15,656,427
d. $15,651,924

69. A company issues $15,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2011.
Interest is paid on June 30 and December 31. The proceeds from the bonds are
$14,703,109. Using straight-line amortization, what is the carrying value of the bonds on
December 31, 2013?
a. $14,752,673
b. $14,955,466
c. $14,725,375
d. $14,747,642

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 73. A company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2011. Interest
is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. Using
straight-line amortization, what is the carrying value of the bonds on December 31, 2013?
a. $9,835,116
b. $9,970,312
c. $9,816,916
d. $9,831,762

The following information applies to both questions 79 and 80.

On October 1, 2012 Bartley Corporation issued 5%, 10-year bonds with a face value of $3,000,000
at 104. Interest is paid on October 1 and April 1, with any premiums or discounts amortized on a
straight-line basis.

79. The entry to record the issuance of the bonds would include a
a. credit of $75,000 to Interest Payable.
b. credit of $120,000 to Premium on Bonds Payable.
c. credit of $2,880,000 to Bonds Payable.
d. debit of $120,000 to Discount on Bonds Payable.

80. Bond interest expense reported on the December 31, 2012 income statement of Bartley
Corporation would be
a. $40,500
b. $69,000
c. $34,500
d. $37,500

93. The 12% bonds payable of Nyman Co. had a carrying amount of $2,080,000 on December
31, 2012. The bonds, which had a face value of $2,000,000, were issued at a premium to
yield 10%. Nyman uses the effective-interest method of amortization. Interest is paid on
June 30 and December 31. On June 30, 2013, several years before their maturity, Nyman
retired the bonds at 104 plus accrued interest. The loss on retirement, ignoring taxes, is
a. $0.
b. $16,000.
c. $24,800.
d. $80,000.

101. In recent year Cey Corporation had net income of $350,000, interest expense of $70,000, and
a times interest earned ratio of 9. What was Cey Corporation's income before taxes for the
year?
a. $700,000
b. $630,000
c. $560,000
d. None of the above.

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 EXERCISES
Ex. 14-119—Amortization of discount or premium.
Grider Industries, Inc. issued $8,000,000 of 8% debentures on May 1, 2012 and received cash
totaling $7,098,102. The bonds pay interest semiannually on May 1 and November 1. The maturity
date on these bonds is November 1, 2020. The firm uses the effective-interest method of amortizing
discounts and premiums. The bonds were sold to yield an effective-interest rate of 10%.
Instructions
Calculate the total dollar amount of discount or premium amortization during the first year (5/1/12
through 4/30/13) these bonds were outstanding. (Show computations and round to the nearest
dollar.)

Solution

Date Interest Cash Discount Carrying

Expense Interest Amortized Value of

Bonds

5/1/2012 $7,098,102

$354,905 $320,000 $34,905

11/1/2012 $7,133,007

$356,650 $320,000

5/1/2013 $36,650 $7,169,657

Total $71,555

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Ex. 14-120—Entries for Bonds Payable.
Prepare journal entries to record the following transactions related to long-term bonds of Quirk Co.
(a) On April 1, 2011, Quirk issued $1,000,000, 9% bonds for $1,075,736 including accrued
interest. Interest is payable annually on January 1, and the bonds mature on January 1,
2021.
(b) On July 1, 2013 Quirk retired $300,000 of the bonds at 102 plus accrued interest. Quirk uses
straight-line amortization.

Solution
(a) Cash.............................................................................................. 537,868

Bonds Payable..................................................................... 500,000

Interest Expense ($500,000 × 9% × 3/12)............................ 11,250

Premium on Bonds Payable................................................ 26,618

(b) Interest Expense............................................................................ 6,340

Premium on Bonds Payable ($26,618 × .3 × 6/117)....................... 410

Cash ($150,000 × 9% × 6/12).............................................. 6,750

Bonds Payable............................................................................... 150,000

Premium on Bonds Payable ($26,618 × .3 × 90/117)..................... 6,142

Cash........................................................................ 153,000

Gain on Redemption of Bonds............................................. 3,142