Name: ________________________ Class: ___________________ Date: __________ ID: A

DEBT FINANCING

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

____ 1. Which of the following represents a liability?

a. The obligation to pay for goods that a company expects to order from suppliers next
year.
b. The obligation to provide goods that customers have ordered and paid for during the
current year.
c. The obligation to pay interest on a five-year note payable that was issued the last day of
the current year.
d. The obligation to distribute share of a company's own common stock next year as a result
of a stock dividend declared near the end of the current year.
____ 2. A short-term note payable with no stated rate of interest should be
a. recorded at maturity value.
b. recorded at the face amount.
c. discounted to its present value.
d. reported separately from other short-term notes payable.
____ 3. At December 31, 2002, Jenkins Sales & Service has a $100,000, 120-day note payable outstanding. The
company has followed the policy of replacing the note rather than repaying it over the last three years. The
company's treasurer says that this policy is expected to continue indefinitely, and the arrangement is
acceptable to the bank to which the note was issued. The proper classification of the note on the December
31, 2002, balance sheet is
a. dependent on the intention of management.
b. dependent on the actual ability to refinance.
c. current liability, unless specific refinancing criteria are met.
d. noncurrent liability.
____ 4. Which of the following does not meet the FASB's definition of a liability?
a. The signing of a three-year employment contract at a fixed annual salary
b. An obligation to provide goods or services in the future
c. A note payable with no specified maturity date
d. An obligation that is estimated in amount
____ 5. 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 plus the present value of the 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 payments made during
the life of the bond.
d. the sum of the face amount of the bond and the periodic interest payments.
____ 6. 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
b. Understate; overstate
c. Overstate; overstate
d. Overstate; understate

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Name: ________________________ ID: A

____ 7. 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' book value 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.
____ 8. 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.
____ 9. 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.
____ 10. 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 new 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.
____ 11. When the interest payment dates of a bond are May 1 and November 1, and the bond is issued on June 1, the
amount of interest expense at December 31 of the year of issuance would be for
a. two months.
b. six months.
c. seven months.
d. eight months.
____ 12. For a bond issue that sells for more than its par value, the market rate of interest is
a. dependent on the rate stated on the bond.
b. equal to the rate stated on the bond.
c. less than the rate stated on the bond.
d. higher than the rate stated on the bond.
____ 13. For the issuer of ten-year bonds, the amount of amortization using the effective-interest method would
increase each year if the bonds were sold at a

Discount Premium

a. No No
b. Yes Yes
c. No Yes
d. Yes No

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Name: ________________________ ID: A

____ 14. Outstanding bonds payable are converted into common stock. Under either the book value or market value
method, the same amount would be debited to

Bonds Premium on
Payable Bonds Payable

a. No No
b. No Yes
c. Yes No
d. Yes Yes
____ 15. The effective interest rate on bonds is lower than the stated rate when bonds sell
a. at maturity value.
b. above face value.
c. below face value.
d. at face value.
____ 16. To compute the price to pay for a bond, you use
a. only the present value of $1 concept.
b. only the present value of an annuity of $1 concept.
c. both a and b.
d. neither a nor b.
____ 17. The net amount of a bond liability that appears on the balance sheet is the
a. call price of the bond plus bond discount or minus bond premium.
b. face value of the bond plus related premium or minus related discount.
c. face value of the bond plus related discount or minus related premium.
d. maturity value of the bond plus related discount or minus related premium.
____ 18. When interest expense is calculated using the effective-interest amortization method, interest expense
(assuming that interest is paid annually) always equals the
a. actual amount of interest paid.
b. book value of the bonds multiplied by the stated interest rate.
c. book value of the bonds multiplied by the effective interest rate.
d. maturity value of the bonds multiplied by the effective interest rate.
____ 19. When a company issues bonds, how are unamortized bond discounts and premiums classified on the balance
sheet?
a. Bond discounts are classified as assets, and bond premiums are classified as contra-asset
accounts.
b. Bond discounts are classified as expenses, and bond premiums are classified as revenues.
c. Bond premiums are classified as additions to, and bond discounts are classified as
deductions from, the face value of bonds.
d. None of the above.

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Name: ________________________ ID: A

____ 20. The net amount required to retire a bond before maturity (assuming no call premium and constant interest
rates) is the
a. issuance price of the bond plus any unamortized discount or minus any unamortized
premium.
b. face value of the bond plus any unamortized premium or minus any unamortized
discount.
c. face value of the bond plus any unamortized discount or minus any unamortized
premium.
d. maturity value of the bond plus any unamortized discount or minus any unamortized
premium.
____ 21. RCM Corporation, a calendar-year firm, is authorized to issue $200,000 of 10 percent, 20-year bonds dated
January 1, 2002, with interest payable on January 1 and July 1 of each year. The entry to account for the
discount amortization and accrual of interest on December 31, 2002, would include a
a. debit to Discount on Bonds Payable.
b. credit to Cash.
c. credit to Interest Payable.
d. debit to Bonds Payable.
____ 22. Accrued interest on bonds that are sold between interest dates
a. is ignored by both the seller and the buyer.
b. increases the amount a buyer must pay to acquire the bonds.
c. is recorded as a loss on the sale of the bonds.
d. decreases the amount a buyer must pay to acquire the bonds.
____ 23. When bonds are sold between interest dates, any accrued interest is credited to
a. Interest Payable.
b. Interest Revenue.
c. Interest Receivable.
d. Bonds Payable.
____ 24. On July 1, 2002, Riviera Manufacturing Co. issued a five-year note payable with a face amount of $250,000
and an interest rate of 10 percent. The terms of the note require Riviera to make five annual payments of
$50,000 plus accrued interest, with the first payment due June 30, 2003. With respect to the note, the current
liabilities section of Riviera's December 31, 2002, balance sheet should include
a. $12,500.
b. $50,000.
c. $62,500.
d. $75,000.
____ 25. Selected financial data of Alexander Corporation for the year ended December 31, 2002, is presented below:

Operating income ...................................... $900,000

Interest expense ...................................... (100,000)
Income before income tax .............................. $800,000
Income tax expense .................................... (320,000)
Net income ............................................ $480,000
Preferred stock dividends ............................. (200,000)
Net income available to common stockholders ........... $280,000

Common stock dividends were $120,000. The times-interest-earned ratio is

a. 2.8 to 1.
b. 4.8 to 1.
c. 6.0 to 1.
d. 9.0 to 1.

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Name: ________________________ ID: A

____ 26. Miller Enterprises had the following long-term debt:

Sinking fund bonds, maturing in installments .......... $1,100,000

Industrial revenue bonds, maturing in installments .... 900,000
Subordinated bonds, maturing on a single date ......... 1,500,000

The total of the serial bonds amounted to

a. $900,000.
b. $1,500,000.
c. $2,000,000.
d. $2,400,000.
____ 27. During the year, Hancock Corporation incurred the following costs in connection with the issuance of bonds:

Printing and engraving ................................ $ 30,000

Legal fees ............................................ 160,000
Fees paid to independent accountants for registration 20,000
information ...........................................
Commissions paid to underwriter ....................... 300,000

The amount recorded as a deferred charge to be amortized over the term of the bonds is
a. $0.
b. $30,000.
c. $300,000.
d. $510,000.
____ 28. On January 1, 2002, Matlock Inc. issued its 10 percent bonds in the face amount of $1,500,000. They mature
on January 1, 2012. The bonds were issued for $1,329,000 to yield 12 percent, resulting in bond discount of
$171,000. Matlock uses the effective-interest method of amortizing bond discount. Interest is payable July 1
and January 1. For the six months ended June 30, 2002, Matlock should report bond interest expense of
a. $75,000.
b. $79,740.
c. $83,550.
d. $85,260.
____ 29. On July 1, 2002, TJR issued 2,000 of its 8 percent, $1,000 bonds for $1,752,000. The bonds were issued to
yield 10 percent. The bonds are dated July 1, 2002, and mature on July 1, 2012. Interest is payable
semiannually on January 1 and July 1. Using the effective-interest method, how much of the bond discount
should be amortized for the six months ended December 31, 2002?
a. $15,200
b. $12,400
c. $9,920
d. $7,600
____ 30. On July 1, 2001, Houston Company purchased as a long-term investment Essex Company's ten-year, 9
percent bonds, with a face value of $100,000 for $95,200. Interest is payable semiannually on January 1 and
July 1. The bonds mature on July 1, 2005. Houston uses the straight-line method of amortization. What is the
amount of interest revenue that Houston should report in its income statement for the year ended December
31, 2001?
a. $3,900
b. $4,500
c. $5,100
d. $5,700

5
Name: ________________________ ID: A

____ 31. Woods, Inc. holds an overdue note receivable of $1,600,000 plus recorded accrued interest of $128,000. As a
result of a court-imposed settlement on December 31, 2002, Woods agreed to the following restructuring
arrangement:

Reduce the principal obligation to $1,200,000. Forgive the $128,000 accrued interest. Extend the maturity
date to December 31, 2004. Annual interest of $120,000 is to be paid to Woods on December 31, 2002 and
2003.

On December 31, 2002, Woods must recognize a loss from restructuring of

a. $0.
b. $288,000.
c. $408,000.
d. $528,000.
____ 32. During 2002, Daly Company experienced financial difficulties and is likely to default on a $500,000, 15
percent, three-year note dated January 1, 2001, and made payable to Summit Bank. On December 31, 2002,
the bank agreed to settle the note and unpaid interest of $75,000 for 2002. The settlement amount is $410,000
cash payable on January 31, 2003. Ignoring income taxes, what amount should Daly report as a gain from the
debt restructuring in its 2002 income statement?
a. $165,000
b. $90,000
c. $75,000
d. $0
____ 33. White Sox Corporation issued $200,000 of 10-year bonds on January 1. The bonds pay interest on January 1
and July 1 and have a stated rate of 10 percent. If the market rate of interest at the time the bonds are sold is 8
percent, what will be the issuance price of the bonds?
a. $175,078
b. $211,283
c. $215,902
d. $227,183
____ 34. White Sox Corporation issued $200,000 of 10-year bonds on January 1. The bonds pay interest on January 1
and July 1 and have a stated rate of 10 percent. If the market rate of interest at the time the bonds are sold is
12 percent, what will be the issuance price of the bonds?
a. $114,699
b. $177,059
c. $190,079
d. $224,926
____ 35. On January 1, 2003, $50,000 of 20-year, 6 percent debentures were issued for $56,275.20. Interest payment
dates on the bonds are January 1 and July 1. The amount of premium to be amortized on July 1, 2003, when
using the straight-line method is
a. $313.76.
b. $156.88.
c. $776.50.
d. $93.11.
____ 36. The total interest expense on a $200,000, 10 percent, 10-year bond issued at 95 would be
a. $190,000.
b. $195,000.
c. $200,000.
d. $210,000.

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Name: ________________________ ID: A

____ 37. Assuming the straight-line method of amortization is used, the average yearly interest expense on a $250,000,
11 percent, 20-year bond issued at 94 would be
a. $26,750.
b. $27,500.
c. $28,250.
d. $29,500.
____ 38. The annual interest expense on a $50,000, 15-year, 10 percent bond issued for $45,650 plus accrued interest
6 months after authorization, assuming straight-line amortization, would be
a. $4,975.
b. $5,000.
c. $5,025.
d. $5,300.
____ 39. Kiyabu County issued a $500,000, 10 percent, 10-year bond on January 1, 2003, for 113.6 when the effective
interest rate was 8 percent. Interest is payable on June 30 and December 31. Kiyabu uses the
effective-interest method to amortize all premiums and discounts. How much interest expense should Kiyabu
record on December 31, 2003?
a. $25,000.00
b. $23,810.15
c. $22,628.80
d. $19,920.10
____ 40. If a $1,000, 9 percent, 10-year bond was issued at 103 plus accrued interest one month after the authorization
date, how much cash did the issuer receive?
a. $1,037.50
b. $1,030.00
c. $1,007.50
d. $992.50
____ 41. RCM Corporation, a calendar-year firm, is authorized to issue $200,000 of 10 percent, 20-year bonds dated
January 1, 2003, with interest payable on January 1 and July 1 of each year. If the bonds were issued on April
1, 2003, the amount of accrued interest on the date of sale is
a. $20,000.
b. $10,000.
c. $5,000.
d. $2,500.
____ 42. If a $6,000, 10 percent, 10-year bond was issued at 104 plus accrued interest two months after the
authorization date, how much cash was received by the issuer?
a. $6,000
b. $6,240
c. $6,340
d. $6,600
____ 43. Johnson Corporation bought a new machine and agreed to pay for it in equal annual installments of $6,000 at
the end of each of the next five years. Assume the prevailing interest rate for this type of transaction is 12%.
Assume the present value of an ordinary annuity of $1 at 12% for five periods is 3.60. The future amount of
an ordinary annuity of $1 at 12% for five periods is 6.35. The present value of $1 at 12% is 0.567. How much
should Johnson record as the note payable on the balance sheet if financial statements were prepared today?
a. $17,010
b. $21,600
c. $30,000
d. $38,100

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Name: ________________________ ID: A

____ 44. On December 31, 2002, Roberts Corporation's current liabilities total $60,000 and long-term liabilities total
$160,000. Working capital at December 31, 2002, is equal to $90,000. If Roberts Corporation's debt-to-equity
ratio is .40 to 1, total long-term assets must equal
a. $620,000.
b. $770,000.
c. $550,000.
d. $680,000.
____ 45. On December 31, 2002, Anderson Company's current liabilities total $55,000 and long-term liabilities total
$155,000. Working capital at December 31, 2002, is equal to $85,000. If Anderson Company's debt-to-equity
ratio is .30 to 1, total long-term assets must equal
a. $910,000.
b. $770,000.
c. $700,000.
d. $825,000.

Problem

46. Monumental Studios, in an effort to promote the release of their new movie "Ninjas from Space," began a
national sales promotion campaign. Two coupons from specially marked boxes (one coupon in each box) of
"Sugar Charms" cereal are redeemable for one ticket to the show. Tickets cost Monumental $1.50 each.
Monumental estimates that 40 percent of the coupons will be redeemed. At the end of 2002, the following
information is available:

Boxes of cereal sold 640,000

Movie tickets purchased by Monumental 140,000
Coupons redeemed 250,000

What is the estimated liability for premium claims outstanding at December 31, (2002?
47. On June 1, 2002, Jefferson Controls, Inc. issued $12,000,000 of 10 percent bonds to yield 12 percent. Interest
is payable semiannually on May 31 and November 30. The bonds mature in 15 years. Jefferson Controls, Inc.
is a calendar-year corporation.

(1) Determine the issue price of the bonds. Show computations.

(2) Prepare an amortization table through the first two interest periods using the
effective-interest method.
(3) Prepare the journal entries to record bond-related transactions as of the following
dates:
(a) June 1, 2002
(b) November 30, 2002
(c) December 31, 2002
(d) May 31, 2003

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Name: ________________________ ID: A

48. The December 31, 2002, balance sheet of Far Imports includes the following items:

(9% bonds payable due 12/31/2011 ...................... $800,000

Discount on bonds payable ............................. 21,600

The bonds were issued on December 31, 2001, at 97, with interest payable on June 30 and December 31 of
each year. The straight-line method is used for discount amortization.

On March 1, 2003, Far Imports retired $400,000 of these bonds at 98 plus accrued interest. Prepare the
journal entries to record retirement of the bonds, including accrual of interest since the last payment and
amortization of the discount.
49. On January 2, 1997, Picard Enterprises issued $2,400,000 of 8 percent, 15-year semiannual coupon bonds to
yield 7.5 percent. Each bond is convertible into 40 shares of $15 par common stock, which was trading at $20
per share on the date of the bond issue. The bonds were issued at 106. Without the conversion feature, the
bonds would have been issued for 104.5.

On January 3, 2002, all of the bonds were converted into common stock. The market price of the stock was
$28 per share on the date of conversion. The issue premium is amortized using the straight-line method.

(1) Provide the journal entry to record issuance of the bonds.

(2) Provide the journal entry to record the conversion of the bonds assuming Picard
considers the conversion
(a) not to be a significant culminating transaction.
(b) to be a significant culminating transaction.
(3) Explain the theoretical justification for either the book value or market value
method of recording conversion.
50. The globalization of business has caused many changes in how enterprises are managed. One such change is
illustrated by U.S. enterprises obtaining loans denominated in foreign currencies.

Identify reasons why such borrowings may occur.

9
 ID: A

DEBT FINANCING
Answer Section

MULTIPLE CHOICE

1. ANS: B
2. ANS: C
3. ANS: C
4. ANS: A
5. ANS: B
6. ANS: C
7. ANS: C
8. ANS: A
9. ANS: A
10. ANS: C
11. ANS: C
12. ANS: C
13. ANS: B
14. ANS: D
15. ANS: B
16. ANS: C
17. ANS: B
18. ANS: C
19. ANS: C
20. ANS: B
21. ANS: C
22. ANS: B
23. ANS: A
24. ANS: C
25. ANS: D
26. ANS: C
27. ANS: D
28. ANS: B
29. ANS: D
30. ANS: C
31. ANS: B
32. ANS: A
33. ANS: D
34. ANS: B
35. ANS: B
36. ANS: D
37. ANS: C
38. ANS: D
39. ANS: C

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 ID: A

40. ANS: A
41. ANS: C
42. ANS: C
43. ANS: B
44. ANS: A
45. ANS: B

PROBLEM

46. ANS:

Number of coupons available 640,000

Expected redemption rate  40%
256,000
(two coupons per ticket)  50%
Estimated premiums 128,000
Premiums redeemed to date (250,000/2 coupons per ticket) 125,000
Expected remaining premiums 3,000
(3,000 tickets  $1.50 each = $ 4,500

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 ID: A

47. ANS:
(1)

Calculation of bond sale price: i = 6% n = 30

Present value of face amount ($12,000,000  .1741) ..... $ 2,089,200
Present value of interest ($600,000  13.7648) ......... 8,258,880
$10,348,080

(2)

Amortization table:
Interest Interest Amortization Carrying
Date Payment Expense of Discount Value
6/1/2002 $10,348,080
11/30/2002 $600,000 $620,885* $20,885 10,368,965
5/31/2003 600,000 622,138** 22,138 10,391,103

Computations:
* $10,348,080  6% = $620,885
** $10,368,965  6% = $622,138

(3)
Journal entries:
(a)
6/1/2002 Cash ........................... 10,348,080
Discount on Bonds Payable ...... 1,651,920
Bonds Payable .................. 12,000,000

(b)
11/30/2002 Interest Expense ............... 620,885
Cash ......................... 600,000
Discount on Bonds Payable .... 20,885

(c)
12/31/2002 Interest Expense
($622,138 x 1/6 = $103,690) ... 103,690
Discount on Bonds Payable
($22,138 x 1/6 = 3,690) ..... 3,690
Interest Payable
($600,000 x 1/6) ............ 100,000

(d)
Assuming no reversing entries:
5/31/2003 Interest Expense ............... 518,448
Interest Payable ............... 100,000
Discount on Bonds Payable .... 18,448
Cash ......................... 600,000

3
 ID: A

48. ANS:

3/1/2003 Interest Expense ................... 6,000

Interest Payable ................. 6,000
($400,000  9%  2/12)

Interest Expense ................... 200

Discount on Bonds Payable ........ 200
$24,000/10 years = $2,400 per year
$2,400  1/2  2/12 = $200

Interest Payable ................... 6,000

Bonds Payable ...................... 400,000
Loss on Early Retirement of Bonds** 2,600
Discount on Bond Payable* ........ 10,600
Cash ($392,000 + $6,000) ......... 398,000
* $10,800 - $200 = $10,600
** Reacquisition Price ($400,000  98%) $392,000
Carrying Value ($400,000 - $10,600).... 389,400
Loss on Early Retirement of Bonds...... $ 2,600

4
 ID: A

49. ANS:

(1)
Issuance of Bonds:
Cash ($2,400,000  106%) .................... 2,544,000
Bonds Payable ............................. 2,400,000
Premium on Bonds Payable .................. 144,000

(2)
Conversion:
(a)
Book value method:
Bonds Payable ............................... 2,400,000
Premium on Bonds Payable .................... 96,000
Common Stock (2,400  40  $15 par) ......... 1,440,000
Paid-In Capital in Excess of Par .......... 1,056,000

Note: The bonds were converted after five years, so 1/3 of the $144,000 issue
premium would have been amortized and 2/3 would be unamortized at the
date of conversion.

(b)
Bonds Payable ............................... 2,400,000
Premium on Bonds Payable .................... 96,000
Loss on Conversion .......................... 192,000
Common Stock (2,400  40  $15 par) ....... 1,440,000
Paid-In Capital in Excess of Par
(2,400  40  $13) ........................ 1,248,000

Note: Paid-In Capital in Excess of Par would be credited for $13 per share ($28 fair
market value - $15 par). A loss is recorded for the difference between the fair
market value of the stock and the carrying value of the bonds.

(3)
Theoretical justification:
Book value method: Most companies record the conversion using the book value method because they do not
want to record a loss on the conversion, which generally arises because an increase in the market value of the
stock triggers the conversion. Use of the book value method is theoretically justified if the conversion is
viewed as the second step of a two-step transaction to issue common stock, the first step being the issuance of
the convertible bonds. Since the issuer's intent was ultimately to issue stock, and the issue price received in
cash is the issue price of the bonds, the book value method accurately reflects the amount of capital provided
by the financing.

5
 ID: A

Market value method: If the issuance of convertible debt is viewed as a separate and independent transaction
from the conversion of the debt, the market value method would be used. Proponents of this view argue that
the issuance of the bonds is a debt transaction and that the loss that generally results upon conversion should
be recorded to disclose the amount of capital foregone by issuing stock through a convertible debt security.
The major advantage to the market value method is that contributed capital is stated at a higher amount than
under the book value method, which may be interpreted positively in the consideration of capital structure.
However, the higher contributed capital is achieved by a corresponding reduction in retained earnings, so
total stockholders' equity is the same using both methods. Since the increase in contributed capital also
necessitates a charge against earnings, most companies prefer to record the conversion using the book value
method.
50. ANS:
U.S. companies may obtain loans denominated in foreign currencies for any or all of the following reasons:

(1) Some countries are reluctant to allow large multinational corporations to do

business in their countries without using local financing.

(2) Use of local sources of financing helps to establish and maintain good local
relations.

(3) Subsidiaries of large multinational corporations may be relatively self contained,

resulting in virtually all operating, investing, and financing activities being handled
locally.

(4) Interest rates in foreign markets may be low relative to those in domestic markets.

(5) Loans denominated in foreign currencies may serve as a hedge of assets held by
the company which are denominated in foreign currency.