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Chapter14: Bonds and Long-Term Notes

Questions for Review of Key Topics

Q 14-1

 

How is periodic interest determined for outstanding liabilities? For outstanding receivables? How does the approach compare from one form of debt instrument (say bonds payable) to another (say notes payable)?

Q 14-2

 

As a general rule, how should long-term liabilities be reported on the debtor's balance sheet?

Q 14-3

 

How are bonds and notes the same? How do they differ?

Q 14-4

 

What information is contained in a bond indenture? What purpose does it serve?

Q 14-5

 

On January 1, 2011, Brandon Electronics issued $85 million of 11.5% bonds, dated January 1. The market yield for bonds of maturity issued by similar firms in terms of riskiness is 12.25%. How can Brandon sell debt paying only 11.5% in a 12.25% market?

Q 14-6

 

How is the price determined for a bond (or bond issue)?

Q 14-7

 

A zero-coupon bond pays no interest. Explain.

Q 14-8

 

When bonds are issued at a premium the debt declines each period. Explain.

Q 14-9

 

Compare the two commonly used methods of determining interest on bonds.

Q 14-10

 

GAAP requires that debt issue costs be recorded separately and amortized over the term of the related debt. Describe a logical alternative to this accounting treatment.

Q 14-11

 

When a note's stated rate of interest is unrealistic relative to the market rate, the concept of substance over form should be employed. Explain.

Q 14-12

 

Mandatorily redeemable shares obligate the issuing company to buy back the shares in exchange for cash or other assets. Where in the balance sheet are these securities reported?

Q 14-13

 

How does an installment note differ from a note for which the principal is paid as a single amount at maturity?

Q 14-14

 

Long-term debt can be reported either (a) as a single amount, net of any discount or increased by any premium or (b) at its face amount accompanied by a separate valuation account for the discount or premium. Any portion of the debt to be paid during the upcoming year, or operating cycle if longer, should be reported as a current amount. Regarding amounts to be paid in the future, what additional disclosures should be made in connection with long-term debt?

Q 14-15

 

Early extinguishment of debt often produces a gain or a loss. How is the gain or loss determined?

Q 14-16

 

What criteria are used to classify a gain or loss on early extinguishment of debt as an extraordinary item in the income statement?

Q 14-17

 

Both convertible bonds and bonds issued with detachable warrants have features of both debt and equity. How does the accounting treatment differ for the two hybrid securities? Why is the accounting treatment different?

Q 14-18

 

At times, companies try to induce voluntary conversion by offering an added incentive—maybe cash, stock warrants, or a more favorable conversion ratio. How is such an inducement accounted for? How is it measured?

Q 14-19

 

Cordova Tools has bonds outstanding during a year in which the market rate of interest has risen. If Cordova has elected the fair value option for the bonds, will it report a gain or a loss on the bonds for the year? Explain.

Q 14-20

 

If a company prepares its financial statements according to International Financial Reporting Standards, how would it account for convertible bonds it issues for $12.5 million? What is the conceptual justification?

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Q 14-21

 

(Based on Appendix A) Why will bonds always sell at their price plus any interest that has accrued since the last interest date?

p. 785

Q 14-22

 

(Based on Appendix B) When the original terms of a debt agreement are changed because of financial difficulties experienced by the debtor (borrower), the new arrangement is referred to as a troubled debt restructuring. Such a restructuring can take a variety of forms. For accounting purposes, these possibilities are categorized. What are the accounting classifications of troubled debt restructurings?

Q 14-23

 

(Based on Appendix B) Pratt Industries owes First National Bank $5 million but, due to financial difficulties, is unable to comply with the original terms of the loan. The bank agrees to settle the debt in exchange for land having a fair value of $3 million. The carrying amount of the property on Pratt's books is $2 million. For the reporting period in which the debt is settled, what amount(s) will Pratt report on its income statement in connection with the troubled debt restructuring?

Q 14-24

 

(Based on Appendix B) The way a debtor accounts for the restructuring depends on the extent of the reduction in cash payments called for by the restructured arrangement. Describe, in general, the accounting procedure for the two basic cases: when, under the new agreement, total cash payments (a) are less than the carrying amount of the debt or (b) still exceed the carrying amount of the debt.

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