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Bonds Payable

BONDS PAYABLE
Essay Questions
1. What is a bond?

A bond is a formal unconditional promise, made under seal, to pay a specified sum of money
at a determinable future date, and to make periodic interest payments at a stated rate until
the principal sum is paid. In simple language, a bond is a contract of debt whereby one party
called the borrower or issuer borrows funds from another party called the investor or
bondholder. A bond indenture or deed of trust is the document which shows in detail the
terms of the bond and the rights and duties of the borrower and other parties to the contract.

2. Define or describe the following types of bonds:

1. Term bonds 7. Coupon or bearer bonds
2. Serial bonds 8. Convertible bonds
3. Mortgage bonds 9. Callable bonds
4. Collateral trust bonds 10. Guaranteed bonds
5. Debenture bonds 11. Junk bonds
6. Registered bonds 12. Commodity-backed bonds

1. Term bonds are bonds with a single date of maturity.

2. Serial bonds are bonds with a series of maturity dates or bonds that mature by
installments.
3. Mortgage bonds are bonds secured by mortgage of real properties.
4. Collateral trust bonds are bonds secured by investments in stocks and bonds.
5. Debenture bonds are bonds without collateral security.
6. Registered bonds require the registration of the name of the bondholder on the books
of the corporation. Consequently, when the bondholder sells a bond, the old bond
certificate is surrendered and a new bond certificate is issued to the buyer. Interest is
paid periodically to the bondholder of record.
7. Coupon or bearer bonds - The name of the bondholder is not registered. Accordingly,
interest is paid periodically to the bearer of the bond or the person submitting a
detachable interest coupon.
8. Convertible bonds are bonds that can be exchanged for equity shares of the issuing
entity.
9. Callable bonds are bonds that can be called in for payment before the date of maturity.
10. Guaranteed bonds are bonds issued whereby another party promises to make payment
if the borrower fails to do so.
11. Junk bonds are high risk and high yield bonds issued by entities that are heavily indebted
or otherwise in weak financial position.

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FINANCIAL ACCOUNTING

12. Commodity-backed bonds are bonds which are redeemable in terms of commodities
such as oil or precious metals.

3. Explain a "premium on bonds payable".

If the sales price of the bonds is more than the face value of the bonds, the bonds are said
to be sold at a premium. The "premium on bonds payable" is in effect gain on the part of the
issuing entity or borrower, because it receives more than what it is obligated to pay under the
bond issue. The obligation of the issuing entity is limited only to the face value of the bonds.
The premium on bonds payable, however, is not treated as an outright gain but amortized
over the life of the bond by debiting premium on bonds payable and crediting interest
expense.

4. Explain a "discount on bonds payable".

If the sales price of the bonds is less than the face value of the bonds, the bonds are said to
be sold at a discount. The "discount on bonds payable" is in effect a loss to the issuing entity
because it receives less than what it is obligated to pay which is equal to the face value.
However, the discount on bonds payable is not treated as outright loss but amortized over
the life of the bonds by debiting interest expense and crediting discount on bonds payable.

5. Explain "bond issue costs".

Bond issue costs or "transaction costs" are incremental costs that are directly attributable to
the issue of bonds payable. Such costs include printing and engraving cost, promotion cost,
legal and accounting fee, registration fee with regulatory authorities, commission paid to
agents and underwriters and other similar charges. Bond issue costs are not treated as
outright expense but amortized over the life of the bond issue in a manner similar to that used
for discount on bonds payable. Bond issue costs are conceived as cost of borrowing and
therefore will increase interest expense. The amortization of bond issue costs is recorded by
debiting interest expense and crediting bond issue costs.

6. Explain the measurement of bonds payable.

PFRS 9, paragraph 5.1.1, provides that bonds payable not designated at fair value through
profit or loss shall be measured initially at fair value minus transaction costs that are directly
attributable to the issue of the bonds' payable. The fair value of the bonds payable is equal
to the present value of the future cash payments to settle the bond liability. Bond issue costs
shall be deducted from the fair value or issue price of the bonds payable in measuring initially

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Bonds Payable

the bonds payable. However, if the bonds are designated and accounted for "at fair value
through profit or loss", the bond issue costs are treated as expense immediately. Actually,
the fair value of the bonds payable is the same as the issue price or net proceeds from the
issue of the bonds, excluding accrued interest.

7. Explain the subsequent measurement of bonds payable.

PFRS 9, paragraph 5.3.1, provides that after initial recognition, bonds payable shall be
measured either:
a. At amortized cost, using the effective interest method
b. At fair value through profit or loss

8. Explain the "amortized cost" of bonds payable.

The "amortized cost" of bonds payable is the amount at which the bond liability is measured
initially minus principal repayment, plus or minus the cumulative amortization using the
effective interest method of any difference between the initial amount and the maturity
amount. Simply stated, the difference between the face amount and present value of the
bonds payable is amortized using the effective interest method. Actually, the difference
between the face amount and present value is either discount or premium on the issue of the
bonds payable. Accordingly, discount on bonds payable and bond issue cost are presented
as deduction from bonds payable and premium on bonds payable is an addition to bonds
payable.

9. Explain the "fair value option" of measuring bonds payable.

PFRS 9, paragraph 4.2.2, provides that at initial recognition, bonds payable may be
irrevocably designated as at fair value through profit or loss. In other words, under the fair
value option, the bonds payable shall be measured initially at fair value and remeasured at
every year-end at fair value and any changes in fair value are recognized in profit or loss.
There is no more amortization of bond issue cost, bond discount and bond premium. As a
matter of fact, interest expense is recognized using the nominal or stated interest rate and
not the effective interest rate.

10. On January 1, 2013, an entity issued bonds with face amount of P5,000,000 and 12% stated
interest rate for P5,379,100. The bonds are sold to yield 10%. Interest is payable annually on
December 31. The entity paid bond issue cost of P100,000. On December 31, 2013, the fair
value of the bonds is determined to be P5,300,000.
Prepare the journal entries for 2013 assuming the entity elects the fair value option of
measuring the bonds payable.

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Jan. 1 Cash 5,379,100

Bonds payable 5,379,100
1 Transaction cost 100,000
Cash 100,000
Dec. 31 Interest expense 600,000
Cash (12% x 5,000,000) 600,000
31 Bonds payable 79,100
Gain from change in fair value 79,100
Bonds payable-January 1, 2013 5,379,100
Fair value - December 31, 2013 5,300,000
Decrease in fair value of bonds - gain 79,100

11. What is the meaning of treasury bonds?

Treasury bonds are an entity's own bonds originally issued and reacquired but not canceled.

12. Explain the accounting for treasury bonds.

When treasury bonds are acquired, the "treasury bonds account" is debited at face value and
any related unamortized premium or discount or issue cost is canceled. The difference
between the acquisition cost and the carrying amount of the treasury bonds is treated as gain
or loss on acquisition of treasury bonds. Any accrued interest paid is charged to interest
expense. Treasury bonds are reported in the statement of financial position as a deduction
from bonds payable.

13. What is meant by bond refunding?

Bond refunding is the floating of new bonds payable the proceeds from which are used in
paying the original bonds payable. Simply stated, bond refunding is the premature retirement
of the old bonds payable through the issuance of new bonds payable.

14. What is the treatment of bond refunding charges?

The refunding charges include the unamortized bond discount or premium, unamortized bond
issue cost and redemption premium on the old bonds being refunded. PFRS 9, paragraph
3.3.1, provides that bond refunding is an extinguishment of a financial liability. Paragraph
3.3.3 further provides that the difference between the carrying amount of the financial liability
extinguished and the consideration paid shall be included in profit or loss. Accordingly, the
refunding charges shall be accounted for as loss on early extinguishment of debt.

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Bonds Payable

15. Explain the "effective interest" method of amortizing discount on bonds payable, premium on
bonds payable and bond issue cost.

The effective interest method or simply "interest method" or scientific method recognizes two
kinds of interest rate - nominal rate and effective rate. The nominal rate is the rate appearing
on the face of the bonds while the effective rate is the actual interest incurred on the bond
issue. The effective rate is the rate that exactly discounts estimated cash future payments
through the expected life of the bonds payable or when appropriate, a shorter period to the
net carrying amount of the bonds payable. The nominal rate is also known as coupon or
stated rate. The effective rate is also known as yield or market rate. If the bonds are sold at
face value, the nominal rate and effective rate are the same. If the bonds are sold at a
discount, the effective rate is higher than nominal rate. If the bonds are sold at a premium,
the effective rate is lower than nominal rate.

Amortization of bond premium or discount. The annual amortization of premium or discount

is the difference between the effective interest expense and nominal interest expense. The
effective interest expense is computed by multiplying the carrying amount of the bonds
payable at the beginning of the year by the effective rate. The nominal interest expense is
computed by multiplying the face value of the bonds payable by the nominal rate. The
effective interest method provides for an increasing amount of discount amortization and
increasing amount of interest expense. The effective interest method provides for an
increasing amount of premium amortization but a decreasing amount of interest expense.
The calculation of effective interest rate shall include all transaction costs, premiums and
discounts. Thus, bond issue costs will increase discount on bonds payable and will decrease
premium on bonds payable. Under the effective interest method, bond issue cost must be
"lumped" with the discount on bonds payable and "netted" against the premium on bonds
payable.

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FINANCIAL ACCOUNTING

COMPOUND FINANCIAL INSTRUMENT

Essay Questions
1. Define a "compound financial instrument".

PAS 32, paragraph 28, defines a compound financial instrument as "a financial instrument
that contains both a liability and an equity element from the perspective of the issuer". In
other words, one component of the financial instrument meets the definition of a financial
liability and another component of the financial instrument meets the definition of an equity
instrument.
The common examples of compound financial instrument are as follows:
a. Bonds payable issued with share warrants
b. Convertible bonds payable

2. Explain the accounting for a compound financial instrument.

The issuer of a financial instrument shall evaluate the terms of the instrument whether it
contains both a liability and an equity component.
If the financial instrument contains both a liability and an equity component, PAS 32,
paragraph 29, mandates that such components shall be accounted for separately in
accordance with the substance of the contractual arrangement and the definition of a financial
liability and an equity.
The approach in accounting for a compound financial instrument is to apply "split accounting".
This means that the consideration received from the issuance of the compound financial
instrument shall be allocated between the liability and equity components.
In other words, the fair value of the liability component is first determined.
The fair value of the liability component is then deducted from the total consideration received
from issuing the compound financial instrument.
The residual amount is allocated to the equity component. QUESTION 5-3

3. Explain bonds payable issued with share warrants.

When the bonds are sold with share warrants, the bondholders are given the right to acquire
shares of the issuing entity at a specified price at some future time.
Actually, when bonds are sold with share warrants two securities are sold - the bonds and
the share warrants.
Share warrants attached to a bond may be detachable or nondetachable.
Detachable share warrants can be traded separately from the bond while nondetachable
share warrants cannot be traded separately.

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Compound Financial Instrument

4. Explain the accounting for bonds payable issued with share warrants.

Bonds issued with share warrants are considered as compound financial instrument.
Accordingly, the proceeds from the issuance of the bonds payable with share warrants shall
be accounted for as partly liability and partly equity.
The proceeds shall be allocated between the bonds payable and the share warrants.
PAS 32 does not differentiate whether the equity component is detachable or nondetachable.
Whether detachable or nondetachable, share warrants have a value and therefore shall be
accounted for separately.
PAS 32, paragraph 31, provides that equity instruments are instruments that evidence a
residual interest in the assets of an entity after deducting all of its liabilities.
Therefore, the bonds are assigned an amount equal to the "market value of the bonds ex-
warrant", regardless of the market value of the warrants.
The residual amount or remainder of the issue price shall then be allocated to the share
warrants.
If the bonds have no known market value ex-warrant, the amount allocated to the bonds is
equal to the present value of the bonds payable.
The present value of bonds payable is the sum of the present value of the principal bond
liability and the present value of the future interest payments using the effective or market
interest rate for similar bonds without the share warrants.

5 Explain the accounting for convertible bonds at the "time of original issuance".

Convertible bonds are conceived as compound financial instrument.

Accordingly, the issuance of convertible bonds shall be accounted for as partly liability and
partly equity.
The issue price of the convertible bonds shall be allocated between the bonds payable and
the conversion privilege.

6. Explain the allocation of the "original issue price" of convertible bonds payable.

The economic effect of issuing convertible bonds is substantially the same as issuing
simultaneously bonds payable with share warrants.

Accordingly, the bonds are assigned an amount equal to the market value of the bonds
without the conversion privilege.

In the absence of market value of the bonds without conversion privilege, the amount
allocated to the bonds is equal to the present value of the bonds payable.

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The present value of bonds payable is the sum of the present value of the principal bond
liability and the present value of future interest payments using the effective or market interest
rate for similar bonds without conversion privilege
The residual amount or remainder of the issue price shall then be allocated to the conversion
privilege or equity component.

7. Explain the accounting for the conversion of convertible bonds into share capital.

If bonds are converted into share capital of the issuing entity, the accounting problem is the
measurement of the share capital issued.
Application Guidance 32 of PAS 32 provides that on conversion of a convertible instrument
at maturity, the entity derecognizes the liability component and recognizes it as equity.
There is no gain or loss on conversion at maturity.
The reason is that the convertible bond is viewed in substance as an equity and the
conversion is really an exchange of one type of equity capital for another.
The conversion is not considered a significant economic transaction and therefore no gain or
loss would be recognized.
Accordingly, the carrying amount of the bonds payable is the measure of the share capital
issued because the carrying amount is the "effective price" for the shares issued as a result
of the conversion.
Any cost incurred in connection with the bond conversion shall be deducted from share
premium, if any. Otherwise, the cost incurred is treated as expense.
The carrying amount of the bonds payable is equal to the face value plus accrued interest if
not paid, plus unamortized premium or minus unamortized discount and bond issue cost.

8. Explain the treatment of the "share premium from the conversion privilege" that was
recognized at the original issuance of the bonds.

The share premium from the conversion privilege that was recognized at the original issuance
of convertible bonds payable shall form part of equity.
If the bonds are later converted, the "share premium from conversion privilege" should be
canceled because this would effectively form part of the total consideration paid for the shares
ultimately issued as a result of the bond conversion.

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Bonds Payable

MCQ – Theory: Bonds Payable

Basic concepts
1. Debentures are
A. Ordinary bonds C. Serial bonds
B. Secured bonds D. Unsecured bonds FA 2 © 2014

2. Bonds for which the bondholders' names are not registered with the issuer are called
A. Bearer bonds C. Serial bonds
B. Debenture bonds D. Term bonds FA 2 © 2014

3. Bonds that pay no interest unless the issuer is profitable are known as
A. Income bonds C. Mortgage bonds
B. Junk bonds D. Registered bonds FA 2 © 2014

4. Bonds issued with scheduled maturities at various dates are called

A. Callable bonds C. Serial bonds
B. Convertible bonds D. Terms bonds FA 2 © 2014

5. Bonds that mature on a single date are called

A. Callable bonds C. Serial bonds
B. Convertible bonds D. Term bonds FA 2 © 2014
6. What is the contract between the issuer of bonds and the bondholders?
A. Bond coupon C. Bond indenture
B. Bond debenture D. Registered bond FA 2 © 2014

7. What is the interest rate written on the face of the bond?

A. Stated rate
B. Coupon rate
C. Nominal rate
D. Coupon rate, nominal rate or stated rate FA 2 © 2014

8. What is the rate of interest actually incurred?

A. Effective rate C. Market, yield or effective rate
B. Market rate D. Yield rate FA 2 © 2014

9. When interest expense for the current year is more than interest paid, the bonds were issued
at
A. A discount C. Face amount
B. A premium D. Cannot be determined FA 2 © 2014

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10. When interest expense for the current year is less than interest paid, the bonds were issued
at
A. A discount C. Face amount
B. A premium D. Cannot be determined FA 2 © 2014
11. For a bond issue which sells for less than face value, the market rate of interest is Wiley 2011
A. Dependent on rate stated on the bond C. Higher than rate stated on the bond
B. Equal to rate stated on the bond D. Less than rate stated on the bond

12. What is the market rate of interest for a bond issue which sells for more than face value?
A. Equal to rate stated on the bond C. Independent of rate stated on the bond
B. Higher than rate stated on the bond D. Less than rate stated on the bond FA 2 © 2014

13. If bonds are issued at a premium, this indicates that

A. The yield and nominal rates coincide
B. The yield rate of interest exceeds the nominal rate
C. The nominal rate of interest exceeds the yield rate
D. No necessary relationship exists between the two rates Valix 2012

14. Which of the following is true of a premium on bonds payable?

A. The premium or bonds payable is a contra shareholders' equity account.
B. The premium on bonds payable is an account that appears only on the books of the
investor.
C. The premium on bonds payable increases when amortization entries are made until
maturity date.
D. The premium on bonds payable decreases when amortization entries are made until the
balance reaches zero at maturity date. S&S 19e

Initial Measurement
15. Bonds payable not designated at fair value through profit loss shall be measured initially at
A. Face amount C. Fair value minus bond issue cost
B. Fair value D. Fair value plus bond issue cost FA 2 © 2014

Bond issue cost

16. Cost of issuing bonds payable
I. Is included in the measurement of the bonds payable measured at amortized cost.
II. Is amortized using the "interest" method over the life of the bonds.
III. Will effectively increase the market rate of interest.
A. I and II only C. II and III only
B. I and III only D. I, II and III FA 2 © 2014

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Bonds Payable

Issued at interest date

17. The market price of a bond issued at a discount is the present value of the principal amount
at the market rate of interest AICPA 1191
A. Less the present value of all future interest payments at the market rate of interest.
B. Plus the present value of all future interest payments at the market rate of interest.
C. Less the present value of all future interest payments at the rate of interest stated on the
bond.
D. Plus the present value of all future interest payments at the rate of interest stated on the
bond.

18. The proceeds from the sale of bonds

A. Will always be equal to the face amount.
B. Will always be less than the face amount.
C. Will always be more than the face amount. FA 2 © 2014
D. May be equal to or more or less than the face amount depending on market interest rate.

19. In theory, the proceeds from the sale of a bond would be equal to
A. The face amount of the bond
B. The sum of the face amount of the bond and the periodic interest payments.
C. The face amount of the bond plus the present value of the interest payments made during
the life of the bond
D. The present value of the principal amount due at the end of the life of the bond plus the
present value of the interest payments made during the life of the bond S&S 19e

Issued between interest dates

20. When the interest payment dates of a bond are May 1 and November 1, and a bond issue is
sold on June 1, the amount of cash received by the issuer will be
A. Increased by accrued interest from May 1 to June 1
B. Decreased by accrued interest from May 1 to June 1
C. Increased by accrued interest from June 1 to November 1
D. Decreased by accrued interest from June 1 to November 1 K, W & W

21. When bonds are sold between interest dates, any accrued interest is credited to
A. Bonds payable C. Interest receivable
B. Interest payable D. Interest revenue S&S 19e

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22. Which of the following is true of accrued interest on bonds that are sold between interest
dates?
A. The accrued interest is extra income to the buyer.
B. The accrued interest is computed at the effective rate.
C. The accrued interest will be paid to the seller when the bonds mature. S&S 19e
D. None of the above

23. A bond issued on June 1 of the current year has interest payment dates of April 1 and October
1. Bond interest expense for the current year ended December 31 is for a period of
A. Three months C. Six months
B. Four months D. Seven months FA 2 © 2014

After initial measurement

24. After initial recognition, bonds payable shall be measured at
I. Amortized cost using the effective interest method.
II. Fair value through profit or loss.
A. I only C. Either I or II
B. II only D. Neither I nor II FA 2 © 2014

25. Under international accounting standard, the valuation method used for bonds payable is
A. Historical cost
B. Maturity amount
C. Discounted cash flow valuation at current yield rate
D. Discounted cash flow valuation at yield rate at issuance FA 2 © 2014

Fair value option

26. Under the fair value option, bonds payable shall be measured initially at FA 2 © 2014
A. Face amount C. Fair value minus bond issue cost
B. Fair value D. Fair value plus bond issue cost

27. Which of the following statements is true in relation to the fair value option of measuring a
bond payable?
I. At initial recognition, an entity may revocably designate a bond payable at fair value
through profit or loss.
II. The bond payable is remeasured at every year-end at fair value and any changes in fair
value are recognized in other comprehensive income.
A. I only C. Both I and II
B. II only D. Neither I nor II FA 2 © 2014

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Bonds Payable

Amortized cost option

28. The "amortized cost" of bonds payable means
A. Face amount minus bond issue cost
B. Face amount plus premium on bonds payable
C. Face amount minus discount on bonds payable
D. Face amount plus premium on bonds payable, minus discount on bonds payable and
minus bond issue cost FA 2 © 2014
Straight-line amortization
29. If bonds are initially sold at a discount and the straight-line method of amortization is used,
interest expense in the earlier years [1]
A. Will be less than the coupon rate of interest.
B. Will exceed what it would have been had the effective interest method of amortization
been used.
C. Will be less than what it would have been had the effective interest method of
amortization been used.
D. Will be the same as what it would have been had the effective interest method of
amortization been used. K, W & W

Effective interest method

30. What is the effective interest rate of a bond measured at amortized cost?
A. The stated rate of the bond.
B. The interest rate currently charged by the entity or by others for similar bond. Valix 12
C. The basic risk-free interest rate that is derived from observable government bond prices.
D. The interest rate that exactly discounts estimated future cash payments through the
expected life of the bond or when appropriate, a shorter period to the net carrying amount
of the bond.

31. When interest expense is calculated using the effective interest method, interest expense
equals
A. Actual amount of interest paid.
B. Maturity value of the bonds multiplied by the effective interest rate.
C. Carrying amount of the bonds multiplied by the stated interest rate.
D. Carrying amount of the bonds multiplied by the effective interest rate. Valix 12

32. Under the effective interest method of amortization, the interest expense is equal to
A. The stated rate of interest multiplied by the face amount of the bonds.
B. The market rate of interest multiplied by the face amount of the bonds. FA 2 © 2014
C. The stated rate of interest multiplied by the beginning carrying amount of the bonds.
D. The market rate of interest multiplied by the beginning carrying amount of the bonds.

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FINANCIAL ACCOUNTING

33. An entity issued a bond with a stated rate of interest that is less than the effective interest
rate on the date of issuance. The bond was issued on one of the interest payment dates.
What should the entity report on the first interest payment date?
A. A debit to the unamortized bond discount.
B. A debit to the unamortized bond premium. Becker 2013
C. An interest expense that is less than the cash payment made to bondholders.
D. An interest expense that is greater than the cash payment made to bondholders.

Discount & premium amortization

34. A discount on bond payable is charged to interest expense FA 2 © 2014
A. Equally over the life of the bond C. Only in the year the bond matures
B. Only in the year the bond is issued D. Using the effective interest method

35. Which of the following statements is true for a bond maturing on a single date when the
effective interest method of amortizing bond discount is used?
A. Interest expense increases each six-month period
B. Nominal interest rate exceeds effective interest rate
C. Interest expense remains constant each six-month period FA 2 © 2014
D. Interest expense as a percentage of the bond carrying amount varies from period to
period
36. When the effective interest method is used, the periodic amortization would
A. Increase if the bonds were issued at a discount.
B. Increase if the bonds were issued at a premium.
C. Decrease if the bonds were issued at a premium.
D. Increase if the bonds were issued at either a discount or a premium. FA 2 © 2014

Carrying amount
37. A five-year term bond was issued on January 1, 2012 at a premium. The carrying amount of
the bond on December 31, 2013 would be
A. Higher than the carrying amount on January 1, 2013
B. The same as the carrying amount on January 1, 2013
C. Lower than the carrying amount on December 31, 2014
D. Higher than the carrying amount on December 31, 2014 Valix 12
38. A five-year term bond was issued on January 1, 2012 at a discount. The carrying amount of
the bond on December 31, 2013 would be
A. Lower than the carrying amount on January 1, 2013
B. Higher than the carrying amount on January 1, 2013
C. The same as the carrying amount on January 1, 2013
D. Higher than the carrying amount on December 31, 2014 Valix 12

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Bonds Payable

Early extinguishment of debt

39. A 20-year bond was issued at a premium with a call provision to retire the bond. When the
bond issuer exercised the call provision on an interest date, the call price exceeded the
carrying amount of the bond. The amount of bond liability removed from the accounts should
have equaled the
A. Cash paid
B. Current market price
C. Call price plus unamortized premium
D. Face amount plus unamortized premium
40. A ten-year term bond was issued at a discount with a call provision to retire the bond. When
the bond issuer exercised the call provision on an interest date, the carrying amount of the
bond was less than the call price. The amount of bond liability removed from the accounts
should have equaled the
A. Call price C. Face amount less unamortized discount
B. Call price less unamortized discount D. Face amount plus unamortized discount

41. When bonds are retired prior to maturity with proceeds from a new bond issue, any gain or
loss from the early extinguishment of debt should be
A. Recognized in retained earnings.
B. Amortized over the life of the new bond issue.
C. Recognized in income from continuing operations.
D. Amortized over the remaining original life of the retired bond issue. FA 2 © 2014
42. An extinguishment of bonds payable originally issued at a premium is made by purchase of
the bonds between interest dates. Which of the following statements is true at the time of
extinguishment?
A. The premium must be amortized up to the purchase date.
B. Interest must be accrued from the last interest date to the purchase date.
C. Any costs of issuing the bonds must be amortized up to the purchase date.
D. All of these statements are true. FA 2 © 2014

Derecognition
43. A ten-year term bond was issued at a discount with a call provision to retire the bond. When
the bond issuer exercised the call provision on an interest date, the carrying amount of the
bond was less than the call price. The amount of bond liability derecognized should have
equaled the
A. Call price
B. Call price less unamortized discount
C. Face amount less unamortized discount
D. Face amount plus unamortized discount FA 2 © 2014

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Effect of transactions
Amortization of bond discount
44. The amortization of discount on bonds payable
A. Decreases the amount of interest expense.
B. Decreases the face amount of bonds payable.
C. Increases the carrying amount of bonds payable.
D. Decreases the carrying amount of bonds payable. FA 2 © 2014

45. How would the amortization of discount on bonds payable affect each of the following?
Wiley 2011 A. B. C. D.
Carrying amount of bond Increase Increase Decrease Decrease
Net income Increase Decrease Increase Decrease

Amortization of bond premium

46. How would the amortization of premium on bonds payable affect each of the following?
Wiley 2011 A. B. C. D.
Carrying amount of bond Increase Increase Decrease Decrease
Net income Increase Decrease Increase Decrease

Accounting error
47. At the beginning of the current year, an entity issued bonds at a discount. The entity
incorrectly used the straight-line method instead of the effective interest method to amortize
the discount. What is the effect of the error on the following amounts at the current year-end?
[2]
AICPA 0591 A. B. C. D.
Bond carrying Overstated Overstated Understated Understated
amount
Retained earnings Overstated Understated Overstated Understated
48. When an entity failed to recognize amortization of discount on bond payable for the current
year, what is the effect of the error on liabilities and equity, respectively?
A. Overstated and Overstated C. Understated and Overstated FA 2 © 2014
B. Overstated and Understated D. Understated and Understated
49. An entity neglected to amortize the discount on outstanding bonds payable. What is the effect
of the failure to record discount amortization on interest expense and bond carrying amount,
respectively?
FA 2 © 2014 A. B. C. D.
Interest expense Overstated Overstated Understated Understated
Bond carrying amount Overstated Understated Overstated Understated

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Bonds Payable

50. An entity neglected to amortize the premium on outstanding bonds payable. What is the effect
of the failure to record premium amortization on interest expense and bond carrying amount,
respectively?
S&S 6e A. B. C. D.
Interest expense Overstated Overstated Understated Understated
Bond carrying amount Overstated Understated Overstated Understated
51. On January 1, 2013, an entity issued bonds at a discount. The bonds mature on December
31, 2017. The entity incorrectly used the straight-line method instead of the effective interest
method to amortize the discount. How is carrying amount of the bonds affected by the error?
AICPA 0595 A. B. C. D.
December 31, 2013 Overstated Overstated Understated Understated
December 31, 2017 Understated No effect Overstated No effect

Presentation & disclosure

52. Bond issue costs should be
A. Expensed in the period when incurred.
B. Deferred and amortized over the life of the bonds.
C. Expensed in the period when the bonds are retired.
D. Recorded as a reduction in the carrying amount of bonds payable. FA 2 © 2014

53. Costs incurred in connection with the issuance of ten-year bonds which sold at a slight
premium shall be
A. Capitalized as organization cost
B. Expensed in the year in which incurred
C. Charged to retained earnings when the bonds are issued Valix 12
D. Reported as a deduction from bonds payable and amortized over the ten-year bond term

54. Unamortized debt discount should be reported as

A. Deferred charge
B. Part of the bond issue cost
C. Direct deduction from the face value of the debt
D. Direct deduction from the present value of the debt FA 2 © 2014

55. The carrying amount of a bond liability is the

A. Call price of the bond plus bond discount or minus bond premium.
B. Face amount of the bond plus related discount or minus related premium.
C. Face amount of the bond plus related premium or minus related discount.
D. Maturity value of the bond plus related discount or minus related premium. FA 2 © 2014

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56. The issuer of a 10-year bond sold at par three years ago with interest payable February 1
and August 1 should report in the year-end statement financial position
A. An addition to bonds payable C. Increase in deferred charge
B. Contingent liability D. Liability for accrued interest FA 2 © 2014

Journal entries
57. If bonds are issued between interest dates, the entry of the issuer could include a
A. Debit to interest payable C. Credit to interest receivable
B. Credit to interest expense D. Credit to unearned interest FA 2 © 2014

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