Accounting 202: Intermediate Accounting II Ch 4. Accounting for Bonds & Notes Payable

annuity

• a series of future cash payments that occur at a regular interval

• must occur regularly - usually monthly, quarterly, or annually

mortgage payment

a regularly occurring series of payments, or annuity, on a real estate loan

other examples of annuities

• life insurance payments

• pension payments

• regular savings account deposits

• some investments

time value of money

money loses its value over time

inflation

during which prices rise and money loses its value

present value of an annuity

• the value today of a stream of future payments

• PV (Annuity) = c₁/ (1 + i)^t + c₂/ (1 + i)^t + c₃/ (1 + i)^t + …c_n/ (1 + i)^t

• PV (Annuity) = c ⋅ [1 - (1 + i)^-n/ i]

Which of the following statements regarding inflation are true?

1. During inflation, prices rise

2. During inflation, money gains value

3. Inflation is independent of supply and demand

4. Recession is the reason a candy bar cost a nickel fifty years ago and now costs more than a dollar

During inflation, prices rise

What is the definition of an annuity?

1. Any type of insurance policy that is offered over a long period of time

2. A series of future cash payments occurring at regular intervals

3. A life insurance policy that pays a claim in payments instead of lump sums

4. A loan with a defined payoff date and regular payments due to the lender

A series of future cash payments occurring at regular intervals

Which of the following examples is an annuity?

1. A lump sum lottery payment

2. These are all examples of annuities

3. Mortgage loan payments

4. A robust portfolio with a lot of volatility

Mortgage loan payments

Which of the following statements is true regarding annuities?

1. Annuities are always lump sum payments.

2. Annuities can have either equal payments or different-amount payments, but they must occur regularly.

3. Annuities can occur regularly or irregularly, and they can have equal payments or different-amount payments.

4. Annuities can occur regularly or irregularly, but must have equal payments.

Annuities can have either equal payments or different-amount payments, but they must occur regularly.

What is the present value of an annuity if the interest rate is 5% per year for 5 years, and the annual payments are $25,000?

1. $108,237

2. $125,000

3. $244,441

4. $500,000

$108,237

Annuity

an interest bearing account that either pays you a fixed amount each month or that you pay into each month

Present Value

the value of the annuity today

What does the P stand for in this formula?

1. The number of payments

2. The fixed payment amount

3. The present value

4. The future value

The fixed payment amount

An annuity has fixed monthly payments of $400, an annual interest rate of 8%, and a total number of 12 payments over one year. What is the present value?

1. $3,723.12

2. $1,400.23

3. $4,598.31

4. 1,234.23

$4,598.31

Determine the interest rate that you will use in the formula for present value if the annual interest rate is 15% and payments are on a monthly basis.

1. 0.132

2. 0.432

3. 0.0125

4. 0.213

0.0125

Calculate the present value of annuity with fixed payments of $500, annual interest rate of 4%, and a total of 3 annual payments.

1. $1,254.23

2. $1,582.23

3. $1,387.55

4. $1,412.32

$1,387.55

The present value of an annuity is the worth of an annuity _____.

1. 10 years ago

2. At the end

3. Today

4. In the future

Today

long-term liabilities

obligations owed by a company for more than a year

bond

similar to an IOU or loan

principal

amount the company borrowed

discount

purchases the bond at a value less than the principal

premium

purchasing the bond at a greater value than the principal

pension

arrangement whereby an employer provides lifetime payments to an employee after they retire

leasing

contractual arrangement between the company and the lessor that gives the company the right to use the equipment in exchange for periodic payments for a specific period of time

capital leases

company retains the equipment after the lease ends

operating lease

lessor keeps the equipment after the lease ends

current

the mortgage payments that will be paid within a year

long-term

payments that will be paid after that year, essentially the balance of the loan

Which of the following statements is accurate when it comes to vesting?

1. Vesting is not an important factor in classifying pension benefits on the balance sheet.

2. Vesting is not an important factor in classifying pension benefits on the income statement.

3. Vesting is an important factor in classifying pension benefits on the balance sheet.

4. Vesting is an important factor in classifying pension benefits on the income statement.

Vesting is an important factor in classifying pension benefits on the balance sheet.

Which of the following statements is true as it concerns a capital lease?

1. A capital lease is listed as a liability on the balance sheet.

2. A capital lease is listed as a liability on the income statement.

3. A capital lease is listed as an expense on the balance sheet.

4. A capital lease is listed as an expense on the income statement.

A capital lease is listed as a liability on the balance sheet.

Emily Management Company purchases new computers for its office. It plans to pay for these completely within the next three months. This is an example of a(n):

1. Current liability

2. Contingent liability

3. Direct liability

4. Long-term liability

Current liability

ABC Computer Firm is currently leasing computers to use for business purposes, but their lease will only run for a five-year period, after which the lessor will take back possession of the computers. How should the cost of this lease be recorded?

1. As an asset on the balance sheet

2. As an expense on the income statement

3. As a liability on the balance sheet

4. As a revenue on the income statement

As an expense on the income statement

Barber Company purchases a new fleet of company vehicles that it will make payments on over the next five years. This is an example of a(n):

1. Current liability

2. Direct liability

3. Long-term liability

4. Contingent liability

Long-term liability

long-term liabilities

obligations owed for more than a year

annuity

represent a series of payments

Liabilities

categorized on the balance sheet as current or long term

Principal

the amount borrowed

interest

cost associated with borrowing the money

bond

similar to an IOU

present value

value of a bond now, in present time, discounted by an interest rate

What is an annuity?

1. An annuity is the cost associated with selling a product or service.

2. An annuity is an obligation owned.

3. An annuity is the cost of doing business.

4. An annuity is a series of payments.

An annuity is a series of payments.

What are long term liabilities?

1. Long term liabilities are a series of payments.

2. Long term liabilities are obligations owned.

3. Long term liabilities are obligations owed for more than a year.

4. Long term liabilities are obligations owed for less than a year.

Long term liabilities are obligations owed for more than a year.

Which of the following statements is TRUE regarding a bond?

1. A bond is an asset for the issuer.

2. A bond is a liability for the issuer.

3. A bond is considered revenue for the issuer.

4. A bond is an expense for the issuer.

A bond is a liability for the issuer.

Which of the following statements is TRUE regarding coupon interest payments?

1. Coupon interest payments are paid periodically.

2. Coupon interest payments are considered an asset for the bond issuer.

3. Coupon interest payments are considered revenue for the bond issuer.

4. Coupon interest payments are optional for bond issuers.

Coupon interest payments are paid periodically.

ABC Paper Corporation is looking to sell $50,000 in bonds with $4,000 in coupon interest payments, and a 6% interest rate due in 10 years. Assume that the 3 digit present value of the bond is .512, and the 3 digit present value of the coupon interest payment is 4.98. What is the present value of the bond?

1. $45,520

2. $38,460

3. $48,790

4. $42,250

$45,520

Secured Bonds

use collateral to financially safeguard the bondholder against the issuer’s default

Unsecured Bonds a.k.a. Debentures

use the issuer’s general credit rating to back the bond

Term Bonds

mature or become due on one specified date

Serial Bonds

a portion of the outstanding bonds matures or become due at several dates, which typically fall in a series

Registered Bonds

• issued in the names and address of their holders

• the registered bond demonstrates ownership with a title

Bearer Bonds

• payable to whoever bears or holds the bond

• anyone could claim ownership of the bond as long as he or she bears it

Convertible Bond

• the bondholder has the right to terminate the bond before the stated maturity date

• provide the bondholder with the right to exchange the bond for a specific number of shares in the company’s common stock before the maturity date

Callable Bond

• issuer has that same right

• allow the issuer the opportunity to retire or payoff a bond at a stated dollar amount before reaching maturity

How is an unsecured bond different from a secured bond?

1. Secured bonds offer higher interest than unsecured bonds.

2. Secured bonds protect only the principal balance, while unsecured bonds do not protect the principal balance.

3. Unsecured bonds offer more tangible assets compared to secured bonds.

4. Unsecured bonds are riskier than secured bonds.

Unsecured bonds are riskier than secured bonds.

X is a type of bond that is payable to whoever holds it. As such, anyone can claim ownership of X. Because of the risk associated with X, very few are in circulation today.

Identify X.

1. Serial bond

2. Callable bond

3. Registered bond

4. Bearer bond

Bearer bond

Which of these bond types provides the bondholder with the right to exchange the bond for a specific number of shares in the company's common stock before the maturity date?

1. Convertible bond

2. Registered bond

3. Serial bond

4. Unsecured bond

Convertible bond

Which of these bond types are bonds in which a portion of the outstanding bonds mature or become due at several dates which typically fall in a series?

1. Unsecured bond

2. Serial bond

3. Convertible bond

4. Registered bond

Serial bond

When does a term bond become mature?

1. On a date as imposed by the issuer

2. On the last day of the year

3. On a specific date as agreed by both the issuer and bondholder

4. On the first of each term

On a specific date as agreed by both the issuer and bondholder

Bond

investment product where the investor loans a corporation money

Discount

amount less than the borrowed amount

Premium

amount greater than the borrowed amount

Coupon Interest Payments

cost of borrowing the money

Present Value

how much the bond is worth today

Premium

present value of the bond will be greater than the future value

Which of the following statements is true regarding bond coupon interest payments?

1. Bond issuers are not obligated to pay annual coupon interest payments.

2. Investors expect annual coupon interest payments.

3. Investors do not expect annual coupon interest payments.

4. The annual coupon interest payments must total the future value.

Investors expect annual coupon interest payments.

ABC Engineering is offering to sell you a bond for $50,000, which will upon maturity be worth $75,000. This bond also has an annual $2,000 coupon interest payment, and the time to maturity is 10 years.

XYZ Tech Firm is offering to sell you a bond for $100,000, which will upon maturity be worth $75,000. This bond also has an annual $15,000 coupon interest payment, and the time to maturity is 5 years.

Based on projected profit, which company's bond should you choose and what will the final profit be?

1. ABC Engineering, $45,000

2. XYZ Tech Firm, $25,000

3. XYZ Tech Firm, $50,000

4. ABC Engineering, $60,000

XYZ Tech Firm, $50,000

Which of the following is true about selling bonds at a discount?

1. Selling bonds at a discount means the purchase price is equal to the future value.

2. Selling bonds at a discount means the purchase price is less than the future value.

3. Selling bonds at a discount means the purchase price is greater than the future value.

4. Selling bonds at a discount means family or friends of the employee can purchase the bond at a lower price.

Selling bonds at a discount means the purchase price is less than the future value.

What are the characteristics of bonds?

1. Long term, lower risk, coupon interest payments

2. Risky, short term, dividends

3. Risky, long term, voting rights

4. Short term, lower risk, coupon interest payments

Long term, lower risk, coupon interest payments

Which of the following statements is true about bonds selling at a premium?

1. Selling bonds at a premium means the purchase price is equal to the future value.

2. Selling bonds at a premium means the purchase price is less than the future value.

3. Selling bonds at a premium means the purchase price is greater than the future value.

4. Selling bonds at a premium relates to the type and class of bond.

Selling bonds at a premium means the purchase price is greater than the future value.

face value

the value of the bond to be paid at maturity

coupon rate

the amount of interest to be received annually

discount rate

required return rate for an investor

majority date

the date the bond will be paid to the investor

premium

when the coupon rate is greater than the discount rate

discounted

when the coupon rate is less than the discount rate

hurdle rate

the minimum return established for investments

weighted average cost of capital

the company’s cost of acquiring the funds used to invest

Smith Darby has issued a five-year bond with a coupon rate of 8% and a face value of $5,000. As a personal investor, you require a rate of return of 10%. What is the value of the bond?

1. $5,000.00

2. $4,620.94

3. $5,399.37

4. $3,050.00

$4,620.94

Kirby Clean has issued a $1,000, three-year bond with a coupon rate of 15%. The investor's required rate of return is 10%. What is the value of the bond?

1. Greater than face value

2. None of the answers are correct

3. Face value

4. Less than face value

Greater than face value

An investor purchased a ten-year bond with a face value of $5,000 seven years ago. The coupon rate is 10% and the discount rate is 5%. The investor now has an opportunity to purchase a second bond with a coupon rate of 15%. The discount rate of similar types of bonds has increased to 10%.

He plans on selling the first bond. What is the value of the first bond if it is sold to a new investor (remember to use the most recent discount rate in the calculation regardless of the original discount rate)?

1. $5,000

2. $5,624.94

3. $6,396.10

4. $5,680.81

$5,000

When the coupon rate is above the discount rate, the bond value is _____ the face value and is considered to be at a _____.

1. Above; premium

2. Above; discount

3. Below; discount

4. Below; premium

Above; premium

The value of a bond is calculated using the present value of discounted cash flows. What is the discount rate?

1. The discount rate is the amount above the face value an investor is willing to pay for the bond.

2. The discount rate is the interest paid to the investor.

3. The discount rate is the difference between the face value and the purchase price expressed as a percentage.

4. The discount rate is the rate of return required for an investor to purchase the bond.

The discount rate is the rate of return required for an investor to purchase the bond.

bond

an investment instrument whereby an investor loans a company money in return for periodic interest payments

maturity date

agreed upon date the bond will be paid back

interest

cost of borrowing the money

retired

once the bond reaches maturity, the investors are repaid in full and the liability is removed from the balance sheet

callable

bond allows the issuer to retire the bond early

Which of the following is true about a bond issuer?

1. A bond issuer pays coupon payments to the investor.

2. A bond issuer is not required to pay coupon payments to the investor.

3. A bond issuer is not required to pay dividends to the investor.

4. A bond issuer pays dividends to the investor.

A bond issuer pays coupon payments to the investor.

How do you report a loss at the early retirement of a bond?

1. Report the loss on the balance sheet as an extraordinary item.

2. Report the loss on the income statement as an expense.

3. Report the loss on the balance sheet as an expense.

4. Report the loss on the income statement as an extraordinary item

Report the loss on the income statement as an extraordinary item

ABC Tech Firm has issued callable bonds for $5000 at a 10% interest rate with a maturity date of 10 years from the date of issue. In year 8, market interest rates have dropped to 4%. What will ABC Tech Firm likely do in this situation?

1. Retire the bond early to issue new bonds which take advantage of the lower interest rate.

2. Wait until the bond reaches maturity and continue to monitor interest rates.

3. Do nothing as a higher interest rate is better for the bond issuer.

4. Wait until the bond reaches maturity to avoid paying extra to retire the bond early.

Retire the bond early to issue new bonds which take advantage of the lower interest rate.

What is the term for the agreed upon date a bond will be paid back?

1. Liability date

2. Payoff date

3. Maturity date

4. Termination date

Maturity date

Which of the following statements is true regarding a callable bond?

1. A callable bond allows the issuer to call the investor about changes in the bond's contract.

2. A callable bond allows the issuer to turn the bond into stock.

3. A callable bond allows the issuer to retire the bond early.

4. A callable bond allows the investor to buy the bond early.

A callable bond allows the issuer to retire the bond early.

note payable

a liability

What accounting term will you see in the journal entries of non-interest bearing notes but NOT in the journal entries for interest-bearing notes?

1. Interest Expense

2. Discount on Note Payable

3. Note Payable

4. Cash

Discount on Note Payable

What is the best way to calculate the difference between an interest-bearing note and a non-interest bearing note?

1. Ask your accountant

2. Write some accounting entries

3. Interest-bearing notes are always less

4. Non-interest bearing notes are always less

Write some accounting entries

For which kind of note is there no direct interest payment?

1. Neither

2. Both

3. Interest bearing note

4. Non-interest bearing note

Non-interest bearing note

What is an implicit interest rate?

1. Future compensation for the money you borrow

2. Flexible interest

3. A non-binding interest rate

4. Suggested interest

Future compensation for the money you borrow

On an interest-bearing note, what will your income statement show before interest begins accruing?

1. The amount of interest you wish to pay

2. The amount of interest you intend to pay

3. The amount you've been lent

4. Nothing

Nothing