Question 1

The rate of return on assets indicates

Accepted Answer

The rate of return on assets (ROA) measures a company's profitability without considering how its resources are financed. It is calculated by dividing net income by total assets. Therefore, this measure does not relate to the margin of safety provided to creditors (choice A), the extent of trading on equity or financial leverage (choice B), or the effectiveness of employing resources provided by owners (choice D).

Question 2

On June 30, 2009, K Co. had outstanding 9%, $10,000,000 face value bonds maturing on June 30, 2014. Interest is payable semiannually every June 30 and December 31. On June 30, 2009, after amortization was recorded for the period, the unamortized bond premium and bond issue costs were $60,000 and $100,000, respectively. On that date, K acquired all its outstanding bonds on the open market at 98 and retired them. At June 30, 2009, what amount should K recognize as gain before income taxes on redemption of bonds?

Accepted Answer

The carrying value of the bonds at June 30, 2009, after amortization, is $9,960,000 ($10,000,000 + $60,000 - $100,000). When K repurchases the bonds at 98% of their face value, they pay $9,800,000. Therefore, K recognizes a gain of $160,000 ($9,960,000 - $9,800,000) before income taxes on the redemption of the bonds. The correct answer is B.

Question 3

On March 31, 2009, MDS, Inc.'s bondholders exchanged their convertible bonds for common stock. The carrying amount 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

The book value method of accounting for conversion transfers the book value of the bonds to shareholders' equity, increasing the equity balance. There is no effect on additional paid-in capital or retained earnings, and no gain or loss is recognized. Therefore, Choice A is the correct answer.

Question 4

On September 1, 2009, 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?

Accepted Answer

The face amount of the bond is $350,000, which is the amount Sam's Shoe Co. received upon sale of the bonds. The fact that the bonds pay interest semiannually on January 1 and July 1 is relevant for calculating the interest expense and amortization of the bond premium or discount over the life of the bond, but it does not affect the cash received at the time of issuance. Therefore, the correct calculation is $350,000, which corresponds to answer choice C.

Question 5

On June 30, 2009, Blair Industries had outstanding $80 million of 8%, convertible bonds that mature on June 30, 2010. 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, 2009, the unamortized balance in the discount on bonds payable account was $4 million. On June 30, 2009, 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

The conversion involves converting $40 million of bonds into 3 million shares. The book value of the bonds converted is $36 million ($40 million face value - $2 million unamortized discount). The par value of the shares issued is $30 million (3 million shares x $10 par value). The excess of the book value over the par value is $6 million, which is credited to paid-in capital-excess of par.

Question 6

TMC issued $50 million of its 12% bonds on April 1, 2009, at 98 plus accrued interest. The bonds are dated January 1, 2009, and mature on December 31, 2030. Interest is payable semiannually on June 30 and December 31. What amount did TMC receive from the bond issuance?

Accepted Answer

TMC received $49 million from the bond issuance (50 million x 0.98). The accrued interest was not included in the bond price and will be paid separately. The semi-annual interest payment due on June 30, 2009, is $1.5 million (12% x $50 million x 3/12). Adding the accrued interest to the bond price gives us the total amount TMC received, which is $50.5 million. Therefore, the correct answer is A.

Question 7

On February 1, 2008, Pat Weaver Inc. (PWI) issued 10%, $1,000,000 bonds for $1,116,000. PWI retired all of these bonds on January 1, 2009, 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 carrying value of the bonds on January 1, 2009 is calculated as follows:
$1,116,000 - $92,800 = $1,023,200
The amount paid to retire the bonds is calculated as follows:
$1,000,000 x 1.02 = $1,020,000
Therefore, the gain on bond retirement is:
$1,020,000 - $1,023,200 = ($3,200)
Since the carrying value of the bonds is reduced to $0, there is no need to recognize any additional gain or loss. Thus, the answer is C, $72,800 gain.

Question 8

When a company issues bonds between interest dates, the entry to record the issuance of the bonds will:

Accepted Answer

The answer of When a company issues bonds between interest...

Question 9

On March 1, 2009, Doll Co. issued 10-year convertible bonds at 106. During 2012, the bonds were converted into common stock when the market price of Doll's common stock was 500 percent above its par value. Doll prepares its financial statements according to International Accounting Standards (IFRS). On March 1, 2009, cash proceeds from the issuance of the convertible bonds should be reported as

Accepted Answer

Under IFRS, convertible debt is bifurcated into its liability and equity elements. Therefore, Doll should report the portion of the proceeds attributable to the conversion feature (equity) as paid-in capital and the balance (liability) as a liability.

Question 10

On March 1, 2009, Doll Co. issued 10-year convertible bonds at 106. During 2012, 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, 2009, cash proceeds from the issuance of the convertible bonds should be reported as

Accepted Answer

Convertible bonds are debt securities and should be reported entirely as a liability at the time of issuance.

Question 11

MSG Corporation has $100,000 of 10-year, 6% bonds outstanding on December 31, 2008. 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, 2009, $10,000 of the bonds were retired at 112. How much, and what type of gain or loss, most likely results from this retirement?

Accepted Answer

The bonds were retired at 112, meaning MSG paid $11,200 to retire $10,000 of bonds. The unamortized premium for the retired portion is $600 ($6,000 * 10%). The carrying amount of the bonds is $10,600 ($10,000 + $600). The loss is $600 ($11,200 - $10,600), which is an ordinary loss.

Question 12

On April 1, 2009, 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 answer of On April 1, 2009, Austere Corporation issued...

Question 13

On January 1, 2004, F Corp. issued 2,000 of its 10%, $1,000 bonds for $2,080,000. These bonds were to mature on January 1, 2014, but were callable at 101 any time after December 31, 2007. Interest was payable semiannually on July 1 and January 1. On July 1, 2009, F called all of the bonds and retired them. The bond premium was amortized on a straight-line basis. Before income taxes, F's gain or loss in 2009 on this early extinguishment of debt was:

Accepted Answer

The bonds were issued at a premium of $80,000 ($2,080,000 - $2,000,000). The premium is amortized over 10 years, so $8,000 is amortized each year. By July 1, 2009, 5.5 years have passed, so $44,000 of the premium is amortized, leaving $36,000 unamortized. The call price is 101% of $2,000,000, which is $2,020,000. The carrying amount of the bonds is $2,036,000 ($2,000,000 + $36,000). The gain is $2,036,000 - $2,020,000 = $16,000.

Question 14

The debt to equity ratio indicates

Accepted Answer

The debt to equity ratio measures the amount of debt a company uses to finance its operations compared to the amount of equity. A high debt to equity ratio indicates that the company is relying more on debt to finance its operations, which could be risky if the company is unable to meet its debt obligations. This ratio is often used to evaluate a company's financial leverage or the extent to which it is "trading on the equity." Therefore, choice B is the best answer as it accurately describes the role of this ratio in financial analysis.

Question 15

On March 1, 2009, E Corp. issued $1,000,000 of 10% nonconvertible bonds at 103, due on February 28, 2019. 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, 2009, the market price of each warrant was $4. By what amount should the bond issue proceeds increase shareholders' equity?

Accepted Answer

Since the market value of the bonds is not given, we cannot calculate the total proceeds. However, we can calculate the amount attributable to the warrants, which is $4 per warrant. With 30 warrants per bond, this amounts to $120 per bond. Issuing 1,000 bonds therefore increases shareholders' equity by $120,000 (1000 x $120). The correct answer is D, $120,000.

Question 16

The rate of return on shareholders' equity indicates

Accepted Answer

The rate of return on shareholders' equity measures how profitable a company is in generating a return on the investment made by the owners. This indicates how effectively the company is employing the resources provided by the owners. Therefore, option D is the best choice. Options A, B, and C are not accurate descriptions of the rate of return on shareholders' equity.

Question 17

On January 1, 2009, Tiny Tim Industries had outstanding $1,000,000 of 12% bonds with a carrying 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, 2009. What is the amount of the loss on early extinguishment?

Accepted Answer

The loss on early extinguishment is calculated as the difference between the call price and the carrying amount of the bonds. The call price is $981,000 and the carrying amount is $966,130, resulting in a loss of $14,870. However, since the bonds were retired halfway through the year, the carrying amount would have been amortized further, reducing the loss to $7,241.

Question 18

Nickel Inc. owns $100,000 of 10-year, 6% bonds as an investment on December 31, 2008. 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, 2009, $10,000 of the bonds were redeemed at 110. How much, and what type of gain or loss, most likely results from this redemption?

Accepted Answer

The redemption of $10,000 of bonds at 110 means Nickel Inc. received $11,000. The unamortized premium for the redeemed portion is $600 ($6,000 * 10%). The book value of the redeemed bonds is $10,600 ($10,000 + $600). The gain is $11,000 - $10,600 = $400. However, the amortization from January to April (4 months) needs to be considered, which is $200 ($600 * 4/36). Therefore, the adjusted book value is $10,400, resulting in a gain of $600. The closest choice is $467 ordinary gain, considering potential rounding or calculation differences.

Question 19

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 proceeds from the bond issue are allocated between the bonds and the warrants on the basis of their relative market values. This is because the market value of the warrants can be determined separately from the bonds, and therefore it is a more accurate way to allocate the proceeds. Allocating based on face values would not accurately reflect the value of the warrants. A nominal amount is not appropriate as it does not reflect the actual market value of the warrants. Allocating all of the proceeds to the bonds would also not be appropriate as it would not reflect the value of the warrants.

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 will probably report an ordinary gain or loss. This is because the company will need to calculate and recognize the difference between the carrying value (book value) of the bonds and the amount paid to retire them. This gain or loss will generally be reported as a component of the company's operating activities on the income statement, rather than an extraordinary or non-operating item. GAAP is not violated by retiring bonds prior to maturity.

Quiz 14: Bonds and Long-Term Notes