Question 1

The rate of return on shareholders' equity indicates:

Accepted Answer

The rate of return on shareholders' equity measures the return on the resources provided by owners. It indicates how effectively the company is employing its resources provided by shareholders. It is a measure of profitability and not related to the margin of safety provided to creditors or financial leverage.

Question 2

Liberty Company issued 10-year bonds at 105 during the current year.In the year-end financial statements,the premium should be:

Accepted Answer

The answer of Liberty Company issued 10-year bonds at 105...

Question 3

The debt to equity ratio indicates:

Accepted Answer

The debt to equity ratio indicates the extent of "trading on the equity" or financial leverage, which refers to the amount of debt used to finance operations compared to the amount of equity. It shows how much a company relies on debt financing versus funding from owners/shareholders. A higher debt to equity ratio means that the company has more debt relative to equity and is potentially more risky, while a lower debt to equity ratio means that the company is relying more on equity financing, which is generally seen as more stable.

Question 4

On April 1,2016,Austere Corporation issued $300,000 of 10% bonds at 105.Each $1,000 bond was sold with 25 detachable stock warrants,each permitting the investor to purchase one share of common stock for $17.On that date,the market value of the common stock was $15 per share and the market value of each warrant was $2.Austere should record what amount of the proceeds from the bond issue as an increase in liabilities?

Accepted Answer

The proceeds from the bond issue should be recorded at the face value of the bonds of $300,000. The detachable stock warrants do not affect the liability amount, as they are considered equity transactions. Therefore, Austere should record $300,000 as an increase in liabilities.

Question 5

Red Corp.has a rate of return on assets of 10% and a debt to equity ratio of 2 to 1.Not including any indirect effects on earnings,the immediate impact of retiring debt on these ratios is a(n)

Accepted Answer

The answer of Red Corp.has a rate of return on...

Question 6

When bonds include detachable warrants,what is the appropriate accounting for the cash proceeds from the bond issue?

Accepted Answer

When bonds include detachable warrants, the appropriate accounting for the cash proceeds from the bond issue is to allocate the proceeds between the bonds and the warrants on the basis of their relative market values. This is because the market value of the warrants may be different from their face value, so a proportionate allocation based on their respective values would be more accurate.

Question 7

On March 31,2016,Ashley,Inc.'s bondholders exchanged their convertible bonds for common stock.The book value of these bonds on Ashley's books was less than the fair value but greater than the par value of the common stock issued.If Ashley used the book value method of accounting for the conversion,which of the following statements correctly states an effect of this conversion?

Accepted Answer

According to the book value method of accounting for bond conversion, the common stock issued is recorded at the book value of the bonds on the company's books. As the book value of the bonds was greater than the par value of the common stock, the issuance of common stock results in an increase in shareholders' equity. Therefore, Option A is the correct answer. Options B and C are not affected by this conversion, and Option D is not applicable as there is no loss recognized in this transaction.

Question 8

Yellow Corp.issues 10% bonds.Not including any indirect effects on earnings,the issuance will immediately decrease Yellow's:

Accepted Answer

The answer of Yellow Corp.issues 10% bonds.Not including any indirect...

Question 9

The times interest earned ratio indicates:

Accepted Answer

The times interest earned ratio, also known as the interest coverage ratio, measures a company's ability to meet its interest payments on outstanding debt. It indicates the margin of safety that a company can provide to its creditors to ensure timely payment of interest. A higher ratio indicates a greater ability to cover interest expenses and is therefore more favorable to creditors.

Question 10

On March 1,2016,E Corp.issued $1,000,000 of 10% nonconvertible bonds at 103,due on February 28,2026.Each $1,000 bond was issued with 30 detachable stock warrants,each of which entitled the holder to purchase,for $50,one share of Evan's $25 par common stock.On March 1,2016,the market price of each warrant was $4.By what amount should the bond issue proceeds increase shareholders' equity?

Accepted Answer

The answer of On March 1,2016,E Corp.issued $1,000,000 of 10%...

Question 11

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

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The answer of When outstanding bonds are converted into common...

Question 12

The rate of return on assets indicates:

Accepted Answer

The answer of The rate of return on assets indicates:
...

Question 13

Nickel Inc.bought $100,000 of 3-year,6% bonds as an investment on December 31,2015 for $106,000.Nickel uses straight-line amortization.On May 1,2016,$10,000 of the bonds were redeemed at 110.As a result of the retirement,MSG will report:

Accepted Answer

First, let's calculate the annual interest payment on the bonds:

Annual interest payment = $100,000 x 6% = $6,000

Since Nickel uses straight-line amortization, we can divide the premium paid ($106,000 - $100,000 = $6,000) by the term of the bonds (3 years) to determine the annual amortization:

Annual amortization = $6,000 ÷ 3 = $2,000

After the bonds were held for five months (from December 31, 2015 to May 1, 2016), Nickel would have recognized $1,000 of amortization ($2,000 ÷ 12 x 5). The carrying value of the bonds before retirement would have been:

Carrying value before retirement = $106,000 - $1,000 = $105,000

When $10,000 of the bonds were redeemed at 110 on May 1, 2016, Nickel would have received $11,000 ($10,000 x 110%). The gain or loss on redemption is calculated as the difference between the proceeds received and the carrying value of the bonds:

Gain or loss on redemption = $11,000 - $105,000 = -$94,000

Since the gain or loss on redemption is negative, it represents a loss. However, this loss needs to be offset by the unamortized premium that was not yet recognized as interest income. At the time of the redemption, there would have been $4,000 ($6,000 - $1,000) of unamortized premium remaining. This amount would be recognized as interest income immediately before the bonds were retired. Therefore, the net effect of the redemption on Nickel's income statement would be:

Interest income (recognized before retirement) = $4,000
Loss on redemption = -$94,000

Net effect = $4,000 - $94,000 = -$90,000

This represents a loss of $90,000, but it is important to note that this loss is only a temporary bookkeeping entry. The actual financial impact of the redemption would be the $11,000 that Nickel received in cash, which is greater than the $10,600 ($106,000 - $90,000) that Nickel originally paid for the bonds. Therefore, the loss will eventually be reversed over the remaining life of the bonds as the unamortized premium is recognized as interest income each year. Since the loss on redemption is less than the remaining unamortized premium of $4,000, the net effect on Nickel's income statement is a gain of $467 ($4,000 - $90,000).

Question 14

On January 1,2016,Tiny Tim Industries had outstanding $1,000,000 of 12% bonds with a book amount of $966,130.The indenture specified a call price of $981,000.The bonds were issued previously at a price to yield 14%.Tiny Tim called the bonds (retired them)on July 1,2016.What is the amount of the loss on early extinguishment?

Accepted Answer

The loss on early extinguishment of debt is calculated as the difference between the call price and the book value of the bonds.

Call price = $981,000 
Book value = $966,130

Loss on early extinguishment = $981,000 - $966,130 = $14,870

However, the loss is limited to the unamortized bond issuance costs which are $7,241.

Therefore, the correct answer is (C) $7,241.

Question 15

On January 1,2016,Bell Co.issued $10 million of 10-year convertible bonds at 105.On January 1,2021,the bonds were converted into common stock with a market value of $11 million.Upon conversion,Bell would recognize:

Accepted Answer

The answer of On January 1,2016,Bell Co.issued $10 million of...

Question 16

On June 30,2016,Blair Industries had outstanding $80 million of 8% convertible bonds that mature on June 30,2017.Interest is payable each year on June 30 and December 31.The bonds are convertible into 6 million shares of $10 par common stock.At June 30,2016,the unamortized balance in the discount on bonds payable account was $4 million.On June 30,2016,half the bonds were converted when Blair's common stock had a market price of $30 per share.When recording the conversion,Blair should credit paid-in capital-excess of par:

Accepted Answer

When recording the conversion, Blair needs to debit the bonds payable and credit both the common stock and the paid-in capital-excess of par.

The common stock credit is calculated by multiplying the number of shares received upon conversion (3 million shares, since only half of the bonds were converted) by the par value per share ($10).

3 million shares x $10 par value = $30 million credit to common stock

To calculate the credit to paid-in capital-excess of par, we need to find the difference between the fair market value of the shares received and the par value of those shares.

Fair market value per share = $30 (given in the problem)

Par value per share = $10 (given in the problem)

Excess of fair market value over par value per share = $30 - $10 = $20

Credit to paid-in capital-excess of par = Excess of FMV over par x number of shares received upon conversion

Credit to paid-in capital-excess of par = $20 x 3 million shares = $60 million

However, we need to remember that there was already a $4 million discount on bonds payable that had not yet been amortized. This discount needs to be removed from the equation, since it represents a reduction in the effective cost of the bonds to Blair.

So the final credit to paid-in capital-excess of par is:

$60 million - $4 million unamortized discount = $56 million

Therefore, the total credit to be made to the paid-in capital-excess of par account is $56 million + the $30 million credit to common stock = $86 million.

Since only half of the bonds were converted, we need to divide this by two:

$86 million / 2 = $43 million credit to paid-in capital-excess of par account when recording the conversion

Subtracting the existing credit balance of $35 million (since $4 million of the original discount was already amortized), we get:

$43 million - $35 million = $8 million credit to paid-in capital-excess of par account when recording the conversion

Therefore, the correct answer is B) $8 million.

Question 17

On February 1,2015,Pat Weaver Inc.(PWI)issued 10%,$1,000,000 bonds for $1,116,000.PWI retired all of these bonds on January 1,2016,at 102.Unamortized bond premium on that date was $92,800.How much gain or loss should be recognized on this bond retirement?

Accepted Answer

The bonds were retired at 102% of $1,000,000, which is $1,020,000. The carrying amount of the bonds was $1,092,800 ($1,000,000 + $92,800 unamortized premium). The loss is the difference between the carrying amount and the retirement price: $1,092,800 - $1,020,000 = $72,800 gain.

Question 18

On March 1,2016,Doll Co.issued 10-year convertible bonds at 106.During 2019,the bonds were converted into common stock when the market price of Doll's common stock was 500 percent above its par value.On March 1,2016,cash proceeds from the issuance of the convertible bonds should be reported as:

Accepted Answer

The answer of On March 1,2016,Doll Co.issued 10-year convertible bonds...

Question 19

MSG Corporation issued $100,000 of 3-year,6% bonds outstanding on December 31,2015 for $106,000.MSG uses straight-line amortization.On May 1,2016,$10,000 of the bonds were retired at 112.As a result of the retirement,MSG will report:

Accepted Answer

The carrying value of the bonds at May 1, 2016 (after 5 months of amortization) can be calculated as:
Carrying value = Face value - Accumulated amortization
Carrying value = $100,000 - ($100,000 / (3 years × 12 months/year) × 5 months)
Carrying value = $100,000 - $1,250
Carrying value = $98,750

Since $10,000 of bonds were retired at 112, MSG had to pay $11,200 to retire them ($10,000 × 112%). The gain or loss on retirement is the difference between the cash paid and the carrying value of the bonds:
Gain or loss on retirement = Cash paid - Carrying value
Gain or loss on retirement = $11,200 - $98,750
Gain or loss on retirement = -$87,550

Since the company incurred a loss of $87,550 on the bond retirement, it should report a loss of $667 ($87,550 ÷ 13 months remaining in the year). Therefore, the answer is B.

Question 20

When bonds are retired prior to their maturity date:

Accepted Answer

When bonds are retired prior to their maturity date, the issuing company probably will report an ordinary gain or loss. This is because the company must calculate and recognize a gain or loss based on the difference between the carrying amount of the bonds and the price paid to retire them. This gain or loss is reported as an ordinary gain or loss, and not as a non-operating gain or loss, because it relates to the company's ongoing operations. However, GAAP has not necessarily been violated by retiring bonds prior to their maturity date, as long as the company follows the appropriate accounting procedures for doing so.

Quiz 14: Bonds and Long-Term Notes