On November 1, Mason Corp.

issued $800,000 of its 10-year, 8% term bonds dated

October 1. The bonds were sold to yield 10%, with total proceeds of $700,000 plus
accrued interest. Interest is paid every April 1 and October 1. What amount should
Mason report for interest payable in its December 31 balance sheet?

$16,000

Interest payable equals the face amount of the bonds, times the nominal (stated)
interest rate, times the portion of the interest period included in the accounting period.
The yield rate and sale between interest periods for an amount including accrued
interest do not affect interest payable. Accordingly, interest payable equals $16,000
[($800,000 × 8%) × (3 ÷ 12 months)].

On June 1 of the current year, Dahli Corp. issued $300,000 of 8% bonds payable at par
with interest payment dates of April 1 and October 1. In its income statement for the
current year ended December 31, what amount of interest expense should Dahli report?

$14,000

Interest expense is a function of time. Thus, regardless of when interest payment dates
occur, interest expense is calculated for the amount of time the bond is outstanding
during the period. The bond was issued June 1, so 7 months of interest have accrued.
Interest for the entire year is $24,000 ($300,000 face amount × 8% stated rate).
Accordingly, interest expense for the year was $14,000 [$24,000 × (7 ÷ 12)]. The full
calculation is unnecessary because $14,000 is the only amount that is more than half of
the 12-month value.

On January 2, Year 3, Gill Co. issued $2 million of 10-year, 8% bonds at par. The bonds,
dated January 1, Year 3, pay interest semiannually on January 1 and July 1. Bond issue
costs were $250,000. The results under the straight-line amortization method are not
materially different from those of the interest method. Thus, Gill amortizes debt issue
costs using the straight-line amortization method. What amount of bond issue costs are
unamortized at June 30, Year 4?

$212,500

Debt issue costs customarily are amortized using the interest method over the term of
the bonds. But the straight-line amortization method may be applied if the results are
not materially different. The amortization is $25,000 per year ($250,000 ÷ 10 years).
Because the bond has been held for 18 months, $37,500 ($25,000 + $12,500) of issue
costs have been amortized by June 30, Year 4. The unamortized issue costs are
$212,500 ($250,000 – $37,500). Debt issue costs are presented as a direct deduction
from the debt liability.

Finch Co. reported a total asset retirement obligation of $257,000 in last year’s financial
statements. This year, Finch acquired assets subject to unconditional retirement
obligations measured at undiscounted cash flow estimates of $110,000 and discounted
cash flow estimates of $68,000. Finch paid $87,000 toward the settlement of previously
recorded asset retirement obligations and recorded an accretion expense of $26,000.
What amount should Finch report for the asset retirement obligation in this year’s
balance sheet?

$264,000

An asset retirement obligation (ARO) reflects a legal obligation arising from the
acquisition, construction, development, or normal operation of an asset. The ARO is
recorded initially as a liability at fair value when incurred, and the liability is adjusted
periodically. The liability decreases when the entity settles part of the ARO. It increases
because of incurrence of a new ARO and the passage of time (accretion expense). The
ARO and the asset retirement cost (the increase in the related long-lived tangible asset
equal to the initial ARO) also are adjusted for changes in estimates. An expected
present value technique ordinarily is used to estimate the fair value of the ARO. In this
question, the fair value of the acquired ARO is meant to be approximated by the
discounted cash flow estimate ($68,000). Thus, the ARO at year end is $264,000.

Beginning balance: $257,000

New ARO (FV): 68,000
Partial settlement: (87,000)
Accretion expense: 26,000
Ending balance: $264,000

The following information relates to noncurrent investments that Fall Corp. placed in
trust as required by the underwriter of its bonds. All of the income and costs on the
investments are charged directly to the fund balance.

Bond sinking-fund balance, 1/1: $450,000

Additional investment during year: 90,000
Dividends on investments: 15,000
Interest revenue: 30,000
Administration costs: 5,000
Carrying amount of bonds payable: 1,025,000

What amount should Fall report in its December 31 balance sheet related to its
noncurrent investment for bond sinking-fund requirements?

$580,000

The year-end balance for the bond sinking fund is the sum of its beginning balance plus
any additional deposits and earnings (i.e., interest and dividends), net of expenses.
Consequently, Fall should report a year-end balance of $580,000 ($450,000 beginning
balance + $90,000 investment + $15,000 dividends received + $30,000 interest earned
– $5,000 costs) on its December 31 balance sheet.

On January 1, bonds with a face amount of $200,000, an 8% annual effective yield, and
a 7% annual coupon rate were sold by Thomas Dynamics, Inc., for $180,000. The
bonds pay interest on January 1 and July 1. Using the effective interest method, the
company’s interest expense for the first 6 months ended July 1 will be

$7,200

Total interest expense for the year equals the carrying amount of the bonds times the
effective rate (yield), or $14,400 ($180,000 × 8%). Half of this amount is $7,200.

Knob Co. transferred real estate pursuant to a troubled debt restructuring to Mene Corp.
in full liquidation of Knob’s liability to Mene.

Carrying amount of liability liquidated: $150,000

Carrying amount of real estate transferred: 100,000
Fair value of real estate transferred: 90,000

What amount should Knob report as a gain (loss) on restructuring of payables?

$60,000 gain

A troubled debt restructuring may occur as an asset exchange, a modification of terms,

or a combination of these two methods. In this instance, the troubled debt restructuring
is effected as an asset exchange. In such an exchange, the asset given up for the
troubled debt must first be adjusted from its carrying amount to its fair value, with a gain
or loss being recognized for the adjustment. The fair value of the asset provided must
then be compared with the carrying amount of the troubled debt. Because the carrying
amount of the troubled debt is $150,000, Knob should recognize a $60,000 gain
($150,000 troubled debt – $90,000 fair value of real estate) on restructuring of payables.

Dixon Co. incurred costs of $3,300 when it issued, on August 31, 20X5, five-year
debenture bonds dated April 1, 20X5. Dixon uses the straight-line method to amortize
bond issue costs. By what amount is 20X5 interest expense increased by the
amortization of bond issue costs?

a) $220
b) $240
c) $495
d) $3,300

b) $240

There are four years and seven months in the bond term (5 years less the 5 months
from April 1 to August 31) or a total of 55 months. Thus, the 20X5 amortization of bond
issue costs, is $240 [(4/55)$3,300]. The bonds were outstanding four months in 20X5.

During Year 2, Lake Co. issued 3,000 of its 9%, $1,000 face value bonds at 101 1/2. In
connection with the sale of these bonds, Lake paid the following expenses:

Promotion costs $ 20,000

Engraving and printing 25,000
Underwriters' commissions 200,000

What amount should Lake record as bond issue costs to be amortized over the term of
the bonds?

a) $0
b) $220,000
c) $225,000
d) $245,000
d) $245,000

All three listed costs are included in bond issue costs and are amortized over the term
of the bonds. All three contribute to the effort of issuing the bonds.

On September 1, Year 1, Cobb Co. issued a note payable to the National Bank in the
amount of $900,000, bearing interest at 12%, and payable in three equal annual
principal payments of $300,000.

On this date, the bank's prime rate was 11%. The first payment for interest and principal
was made on September 1, Year 2.

At December 31, Year 2, Cobb should record accrued interest payable of

a) $36,000.
b) $33,000.
c) $24,000.
d) $22,000.

c) $24,000.

As of 12/31/Year 2, the first $300,000 principal installment has been paid, along with
interest. This payment was made 9/1/Year 2. The remaining principal outstanding on
that date is $600,000 ($900,000 − $300,000). Thus, accrued interest on 12/31/Year 2 is
$24,000 = 600,000(.12)(4/12).

On June 30, 20X5, Huff Corp. issued at 99, 1000 of its 8%, $1,000 bonds. The bonds
were issued through an underwriter to whom Huff paid bond issue costs of $35,000.

On June 30, 20X5, Huff should report the bond liability at

a) $955,000.
b) $990,000.
c) $1,000,000.
d) $1,025,000.

a) $955,000.

This answer is correct. The $955,000 is the $1,000,000 face value less the $10,000
discount. The discount is computed as (1.00 − .99)($1,000,000) = $10,000, which is the
face value less the bond price. The $990,000 is then reduced by the bond issue costs of
$35,000. Another way to compute the net bond liability at issuance is to apply the unit
bond price to the total face value: $990,000 = .99($1,000,000).

On November 1, 20X5, Mason Corp. issued $800,000 of its 10-year, 8% term bonds
dated October 1, 20X5. The bonds were sold to yield 10%, with total proceeds of
$700,000 plus accrued interest. Interest is paid every April 1 and October 1. What
amount should Mason report for interest payable in its December 31, 20X5 balance
sheet?

a) $17,500
b) $16,000
c) $11,667
d) $10,667

b) $16,000

One month of accrued interest was collected from the bondholders at issuance for the
period October 1—November 1, and interest for the next two months to December 31
was accrued.

Total accrued interest is $16,000 = $800,000(.08)(3/12).

On December 31, Year 1, Arnold, Inc., issued $200,000, 8% serial bonds, to be repaid
in the amount of $40,000 each year. Interest is payable annually on December 31. The
bonds were issued to yield 10% per year. The bond proceeds were $190,280 based on
the present values at December 31, Year 1, of the five annual payments:

Arnold amortizes the bond discount by the interest method. In its December 31, Year 2,
balance sheet, at what amount should Arnold report the carrying amount of the bonds?

$153,308

The carrying amount of the bonds at the end of Year 1 equals the proceeds of
$190,280. Interest expense for Year 2 at the 10% effective rate is thus $19,028. Actual
interest paid is $16,000, discount amortization is $3,028 ($19,028 – $16,000), and the
discount remaining at year end is $6,692 [($200,000 face amount – $190,280 issue
proceeds) – $3,028 discount amortization]. Given that $40,000 in principal is paid at
year end, the December 31, Year 2, carrying amount is $153,308 ($160,000 face
amount – $6,692 unamortized discount).
Roaster Company issued bonds with detachable stock warrants. Each warrant granted
an option to buy one share of $40 par value common stock for $75 per share. Five
hundred warrants were originally issued, and $4,000 was appropriately credited to
warrants. If 90% of these warrants are exercised when the market price of the common
stock is $85 per share, how much should be credited to capital in excess of par on this
transaction?

$19,350

If 90% of the warrants are exercised, 450 shares must be issued at $75 per share. The
total debit to cash is $33,750. The debit to stock warrants outstanding reflects the
exercise of 90% of $4,000 of warrants, or $3,600. The par value of the common stock
issued is credited for $18,000 (450 shares × $40 par). The balance of $19,350 ($33,750
+ $3,600 – $18,000) is credited to capital in excess of par. The transaction is based on
the exercise price, not the fair value of the stock or warrants at the time of issuance.
Cash $33,750
Warrants 3,600
Common stock at par $18,000
Capital in excess of par 19,350

On January 1, Year 1, Gilson Corporation issued 1,000 of its 9%, $1,000 callable bonds
for $1,030,000. The bonds are dated January 1, Year 1, and mature on December 31,
Year 15. Interest is payable semiannually on January 1 and July 1. The bonds can be
called by the issuer at 102 on any interest payment date after December 31, Year 5.
The unamortized bond premium was $14,000 at December 31, Year 8, and the market
price of the bonds was 99 on this date. In its December 31, Year 8, balance sheet, at
what amount should Gilson report the carrying value of the bonds?

$1,014,000

The face amount of the bonds is $1,000,000 (1,000 × $1,000), and the unamortized
premium is $14,000 (given). The carrying amount is thus $1,014,000. The other data
are irrelevant.

On July 1, Year 3, Lundy Company issued for $438,000 500 of its 8%, $1,000 bonds.
The bonds were issued to yield 10%. The bonds are dated July 1, Year 3, and mature
on July 1, Year 13. Interest is payable semiannually on January 1 and July 1. Using the
interest method, how much of the bond discount should be amortized for the 6 months
ended December 31, Year 3?

$1,900

Interest expense for the 6 months since the bonds were issued is $21,900 [$438,000
carrying amount × 10% effective rate × (6 ÷ 12)]. The periodic cash payment is $20,000
[$500,000 face amount × 8% stated rate × (6 ÷ 12)]. The $1,900 ($21,900 – $20,000)
difference is the amount of discount to be amortized for this 6-month interest period.

Young Co. issues $800,000 of 10% bonds dated January 1, Year 1. Interest is payable
semiannually on June 30 and December 31. The bonds mature in 5 years. The current
market rate for similar bonds is 8%. The entire issue is sold on the date of issue. The
following values are given:

What amount of proceeds on the sale of bonds should Young report?

$864,884

The proceeds received from the issuance of bonds equal the sum of the present value
of the cash flows associated with the bonds (both the face amount and interest
payments) discounted at the interest rate prevailing in the market at the time. The
present value of the $800,000 face amount discounted at the market interest rate of 8%
is equal to $540,448 ($800,000 × .67556). The present value of the semiannual interest
payments of $40,000 [$800,000 × 10% × (6 months ÷ 12 months)] discounted at the
market interest rate of 8% is equal to $324,436 ($40,000 × 8.11090). Thus, the
proceeds on the sale of the bonds equal $864,884 ($540,448 + $324,436).

Chambers Company bought Machine 1 on March 5, Year 1, for $5,000 cash. The
estimated salvage was $200 and the estimated life was 11 years. On March 5, Year 2,
the company learned that it could purchase a different machine for $8,000 cash. It
would save the company an estimated $250 per year. The new machine would have no
estimated salvage and an estimated life of 10 years. The company could sell Machine 1
for $3,000 on March 5, Year 2. Ignoring income taxes, which of the following
calculations would best assist the company in deciding whether to purchase the new
machine?

(Present value of an annuity of $250) + $3,000 – $8,000.

The sale of the first machine for $3,000 and the purchase of the new machine for
$8,000 on 3/5/Year 2 results in an incremental cost to the company of $5,000. If the
present value of the future savings from the second machine (present value of an
annuity of $250) exceeds $5,000, the company should purchase the new machine. Note
that the remaining estimated useful life of the first machine is the same as that of the
second. Note also that the cost of Machine 1 should be ignored because it is a sunk
cost.

On January 1, Evangel Company issued 9% bonds in the face amount of $100,000,

which mature in 5 years. The bonds were issued for $96,207 to yield 10%, resulting in a
bond discount of $3,793. Evangel uses the effective interest method of amortizing bond
discount. Interest is payable annually on December 31.

What is the amount of Evangel’s unamortized bond discount at the end of the first year?

$3,172

Total interest expense for the year equals the carrying amount of the bonds times the
effective rate (yield), or $96,207 × 10% = $9,621. Subtracting the cash interest payment
from this leaves the amount of discount amortized ($9,621 – $9,000 = $621).
Subtracting this amount from the previous unamortized discount ($3,793) leaves a
remaining unamortized discount at the end of Year 1 of $3,172.

On July 1, Year 4, Ahmed signed an agreement to operate as a franchisee of Teacake

Pastries, Inc., for an initial franchise fee of $240,000. On the same date, Ahmed paid
$80,000 and agreed to pay the balance in four equal annual payments of $40,000
beginning July 1, Year 5. The down payment is not refundable, and no future services
are required of the franchisor. Ahmed can borrow at 14% for a loan of this type.

Present value of $1 at 14% for 4 periods: 0.59

Future amount of $1 at 14% for 4 periods: 1.69
Present value of an ordinary annuity of $1 at 14% for 4 periods: 2.91

Ahmed should record the acquisition cost of the franchise on July 1, Year 4, at

$196,400

The acquisition cost would have been recorded at $240,000 if this amount of cash had
been paid immediately. Given that the $240,000 is to be paid in installments, the
acquisition cost is equal to the down payment of $80,000 plus the present value of the
series of 4 annuity payments beginning 1 year after the date of purchase. The proper
interest factor to be employed is the present value of an ordinary annuity of $1 at 14%
for 4 periods, or 2.91.
Periodic payment: $40,000
Times: PV factor: ×2.91
PV of periodic payments: $116,400
Plus: down payment: +80,000
PV of franchise fee: $196,400

On July 31, Year 4, Dome Co. issued $1,000,000 of 10%, 15-year bonds at par and
used a portion of the proceeds to call its 600 outstanding 11%, $1,000 face amount
bonds due on July 31, Year 14, at 102. On that date, unamortized bond premium
relating to the 11% bonds was $65,000. In its Year 4 income statement, what amount
should Dome report as gain or loss, before income taxes, from retirement of bonds?

$53,000 gain

The excess of the net carrying amount of the bonds over the reacquisition price is a
gain from extinguishment. The carrying amount of the bonds equals $665,000
($600,000 face amount + $65,000 unamortized premium). The reacquisition price is
$612,000 (600 bonds × $1,000 face amount × 1.02). Thus, the gain from
extinguishment is $53,000 ($665,000 – $612,000).

On Mar. 1, Year 1, Cain Corp. issued, @ 103 plus accrued interest, 200 of its 9%,
$1,000 bonds. The bonds are dated Jan. 1, Year 1, and mature on January 1, Year 11.
Interest is payable semiannually on Jan. 1 and Jul. 1. Cain paid bond issue costs of
$10,000. Cain should realize net cash receipts from the bond issuance of:

A. $216,000
B. $209,000
C. $206,000
D. $199,000

D. $199,000: [$206,000 bond proceeds + 3,000 accrued interest - $10,000 bond issue
costs

12.) On December 30, Year 4, Fort, Inc., issued 1,000 of its 8%, 10-year, $1,000 face
bonds with detachable stock warrants at par. Each bond carried a detachable warrant
for one share of Fort's common stock at a specified option price of $25 per share.
Immediately after issuance, the market value of the bonds without the warrants was
$1,080,000, and the market value of the warrants was $120,000. In its Dec. 31, Year 4,
balance sheet, what amount should Fort report as bonds payable?

A. $1,000,000
B. $975,000
C. $900,000
D. $880,000

C. $900,000: [$1,000,000 x 90%]

13.) On June 30, Year 7, King Co. had outstanding 9%, $5,000,000 face value bonds
maturing on June 30, Year 9. Interest was payable semiannually ever June 30 and Dec.
31. On June 30, Year 7, after amortization was recorded for the period, the unamortized
bond premium and bond issue costs were $30,000 and $50,000. Not that date, King
acquired all its outstanding bonds on the open market at 98 and retired them. At June
30, Year 7, what amount should King recognize as gain before income taxes on
redemption of bonds?

A. $20,000
B. $80,000
C. $120,000
D. $180,000

B. $80,000: [difference between the carrying amount ($4,980,000) and the amount paid
$4,900,000 ($5,000,000 x 98%)

4.) Ray Finance, Inc. issued a 10-year, $100,000, 9% note on Jan. 1, Year 1. The note
was issued to yield 10% for proceeds of $93,770. Interest is payable semiannually. the
note is callable after 2 years at a price of $96,000. Due to a decline in the market rate to
8%, Ray retired the note on Dec. 31, Year 3. On that date, the carrying amount of the
note was $94,582, and the discounted amount of its cash flows based on the market
rate was $105,280. What amount should Ray report as gain (loss) from retirement of the
note for the year ended Dec. 31, Year 3?

A. $9,280
B. $4,000
C. ($2,230)
D. ($1,418)

D. ($1,418): [$94,582 carrying amount - $96,000 amount paid)

15.) On December 31, Year 4, Large, Inc., had a $750,000 note payable outstanding
due July 31, Year 5. Largo borrowed the money to finance construction of a new plant.
Largo planned to refinance the note by issuing concurrent bonds. Because Largo
temporarily had excess cash, it prepaid $250,000 of the note on Jan. 12, Year 5. In
February Year 5, Largo completed a $1.5 million bond offering, Largo will use the bond
offering proceeds to repay the note payable at its maturity and to pay construction costs
during Year 5. On March 3, Year 5, Largo issued its Year 4 financial statements. What
amount of the note payable should Largo include in the current liabilities section of its
December 31, Year 4, balance sheet?

A. $750,000
B. $500,000
C. $250,000
D. $0

C. $250,000

16.) Verona Co. had $500,000 in current liabilities at the end of the current year. Verona
issued $400,000 of common stock subsequent to the end of the year but before the
financial statements were issued. The proceeds from the stock issue were intended to
be used to pay the current debt. What amount should Verona report as a current liability
on its balance sheet at the end of the current year?

A. $0
B. $100,000
C. $400,000
D. $500,000

B. $100,000