FIN

CHAPTER 15
BONDS PAYABLE AND INVESTMENTS IN BONDS

Chapter 15—Bonds Payable and Investments in Bonds
TRUE/FALSE
1. A bond is simply a form of an interest bearing note.
ANS: T DIF: 1 OBJ: 01
2. Bondholders are creditors of the issuing corporation.
3. Bonds of major corporations are traded on bond exchanges.
4. Issuing bonds to finance a company's operations generally has a greater impact on earnings
per share than issuing common stock.
5. Bondholders claims on the assets of the corporation rank ahead of stockholders.
6. A bond is usually divided into a number of individual bonds of $500 each.
ANS: F DIF: 1 OBJ: 02
7. A secured bond is called a debenture bond and is backed only by the general
creditworthiness of the corporation.
8. If the bondholder has the right to exchange a bond for shares of common stock, the bond is
called a convertible bond.
9. The prices of bonds are quoted as a percentage of the bonds' market value.
10. The face value of a term bond is payable at a single specific date in the future.
11. When a corporation issues bonds, it executes a contract with the bondholders, known as a
bond debenture.
12. The market rate of interest is affected by a variety of factors, including investors' assessment
of current economic conditions.
13. The concept of present value is that an amount of cash to be received at some date in the
future is the equivalent of the same amount of cash held at an earlier date.
14. The buyer determines how much to pay for the bonds by computing the present value of
these future cash receipts using the contract rate of interest.
15. When the market rate of interest is less than the contract rate for a bond, the bond will sell
for a premium.
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16. Bonds are sold at face value when the contract rate is equal to the market rate of interest.
17. The present value of the periodic bond interest payments is the value today of the amount of
interest to be received at the end of each interest period.
18. An equal stream of periodic payments is called an annuity.
19. The present value of an annuity is the sum of the present values of each cash flow.
20. The present value of $5,000 to be received in 4 years at a market rate of interest of 6%
compounded annually is $3,636.30.
21. If $500,000 of 10-year bonds, with interest payable semiannually, are sold for $494,040
based on (1) the present value of $500,000 due in 20 periods at 5% plus (2) the present value
of twenty, $25,000 payments at 5%, the nominal or contract rate and the market rate of
interest for the bonds are both 10%.
22. The price of a bond is equal to the sum of the interest payments and the face amount of the
bonds.
23. One reason a dollar today is worth more than a dollar 1 year from today is the time value of
money.
24. If the market rate of interest is 8% and a corporation's bonds bear interest at 7%, the bonds
will sell at a premium.
25. To determine the six month interest payment amount on a bond, you would take one-half of
the market rate times the face value of the bond.
26. Interest payments on 10% bonds with a face value of $10,000 and interest paid semiannually
would be $1,000 every 6 months.
27. Amortization is the allocation process of writing off bond premiums and discounts to
interest expense over the life of the bond issue.
28. If bonds are sold for a discount, the carrying value of the bonds is equal to the face value
less the unamortized discount.
29. The total interest expense over the entire life of a bond is equal to the sum of the interest
payments plus the total discount or minus the total premium related to the bond.
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30. Premium on bonds payable may be amortized by the straight-line method if the results
obtained by its use do not materially differ from the results obtained by use of the interest
method.
31. If the straight-line method of amortization is used, the amount of unamortized premium on
bonds payable will decrease as the bonds approach maturity.
32. If the straight-line method of amortization of discount on bonds payable is used, the amount
of yearly interest expense will increase as the bonds approach maturity.
33. There are two methods of amortizing a bond discount or premium: the straight-line method
and the double-declining-balance method.
34. The effective-interest method of amortizing a bond discount or premium is the preferred
method
35. The amount of interest expense reported on the income statement will be more than the
interest paid to bondholders if the bonds were originally sold at a discount.
36. The amortization of a premium on bonds payable decreases bond interest expense.
37. If the amount of a bond premium on an issued 11%, 4-year, $100,000 bond is $12,928, the
semiannual straight-line amortization of the premium is $1,416.
38. If the amount of a bond premium on an issued 11%, 4-year, $100,000 bond is $12,928, the
annual interest expense is $5,500.
39. Zero-coupon bonds do not provide for interest payments.
40. The issue price of zero-coupon bonds is the present value of their face amount.
41. The special fund that is set aside to provide for the payment of bonds at maturity is called a
sinking fund.
42. At 12/31/2006, the cash and securities held in a sinking fund to redeem bonds in 2007 are
classified on the balance sheet as current assets.
43. If sinking fund cash is used to purchase investments, those investments are reported on the
balance sheet as marketable securities.
44. Both callable and non-callable bonds can be purchased by the issuing corporation in the
open market.
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45. There is a loss on redemption of bonds when bonds are redeemed above carrying value.
46. When a portion of a bond issue is redeemed, a related proportion of the unamortized
premium or discount must be written off.
47. A corporation often issues callable bonds to protect itself against significant declines in
future interest rates.
48. Callable bonds can be redeemed by the issuing corporation at the fair market price of the
bonds.
49. Only callable bonds can be purchased by the issuing corporation before maturity.
50. Callable bonds are redeemable by the issuing corporation within the period of time and at
the price stated in the bond indenture.
51. The carrying amount of the bonds is defined as the face value of the bonds plus any
unamortized discount or less any unamortized premium.
52. If bonds of $1,000,000 with unamortized discount of $10,000 are redeemed at 98, the gain
on redemption of bonds is $10,000.
53. Gains and losses on the redemption of bonds are reported as other income or other expense
on the income statement.
54. Bonds may be purchased directly from the issuing corporation or through one of the bond
exchanges.
55. As with other assets, the cost of a bond investment includes all costs related to the purchase.
56. The cost of bonds purchased as an investment includes the amount paid to the seller for
interest accrued from the last interest payment date to the date of purchase.
57. When a bond is purchased for an investment, the premium or discount is normally not
recorded.
58. When bonds held as long-term investments are purchased at a price other than the face
value, the premium or discount should be amortized over the remaining life of the bonds.
59. The amount of interest paid when buying a bond as an investment should be credited to
Interest Revenue.
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60. The amortization of discount on bonds purchased as a long-term investment increases the
amount of the investment account.
61. To record the amortization of a premium on a bond investment, Investment in Bonds would
be debited and Interest Revenue would be credited.
62. When long-term investments in bonds are sold before their maturity date, the seller would
receive the sales price less commissions plus any accrued interest since the last interest
payment date.
63. If the proceeds from the sale of bonds held as a long-term investment exceed the carrying
amount of the bonds, a gain is realized.
64. Any gains or losses on the sale of long-term investments normally would be reported in the
Other Income or Other Loss section of the income statement.
65. Investments in bonds that are expected to be held for the long term are listed in the
investments section of the balance sheet.
66. Bonds payable would be listed at their carrying value on the balance sheet.
67. The fair market value of bond investments should be disclosed, either on the face of the
financial statements or in an accompanying note.
68. The unamortized Discount on Bonds Payable account is a contra-liability account.
69. The balance in Premium on Bonds Payable should be reported as a deduction from Bonds
Payable on the balance sheet.
70. The balance in a bond discount account should be reported on the balance sheet as a
deduction from the related bonds payable.
71. Investments in bonds that management intends to hold to maturity are called held-to-
maturity securities.
72. Investments in Bonds are reported on the balance sheet at lower of cost or market.
73. Investment in Bonds is listed on the balance sheet after Bonds Payable.
74. The higher the times interest earned ratio, the better the debtors' protection.
75. The times interest earned ratio is calculated by dividing Bonds Payable by Interest Expense.
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MULTIPLE CHOICE
1. When a corporation issues bonds, the price that buyers are willing to pay for the bonds does
not depend on which of the following below
a. face value of the bonds
b. market rate of interest
c. periodic interest to be paid on the bonds
d. denominations the bonds are sold
ANS: D DIF: 1 OBJ: 01
2. A corporation would not be successfully trading on equity if it gathered funds by
a. issuing common stock
b. issuing preferred stock
c. issuing notes
d. issuing bonds
ANS: A DIF: 2 OBJ: 01
3. One potential advantage of financing corporations through the use of bonds rather than
common stock is
a. the interest on bonds must be paid when due
b. the corporation must pay the bonds at maturity
c. the interest expense is deductible for tax purposes by the corporation
d. a higher earnings per share is guaranteed for existing common shareholders
ANS: C DIF: 1 OBJ: 01
4. A bond indenture is
a. a contract between the corporation issuing the bonds and the underwriters selling
the bonds
b. the amount due at the maturity date of the bonds
c. a contract between the corporation issuing the bonds and the bond trustee, who is
acting on behalf of the bondholders.
d. the amount for which the corporation can buy back the bonds prior to the maturity
date
5. Debenture bonds are
a. bonds secured by specific assets of the issuing corporation
b. bonds that have a single maturity date
c. issued only by the federal government
d. issued on the general credit of the corporation and do not pledge specific assets as
collateral.
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6. When the corporation issuing the bonds has the right to repurchase the bonds prior to the
maturity date for a specific price, the bonds are
a. convertible bonds
b. unsecured bonds
c. debenture bonds
d. callable bonds
7. When the maturities of a bond issue are spread over several dates, the bonds are called
a. serial bonds
b. bearer bonds
c. debenture bonds
d. term bonds
8. The market interest rate related to a bond is also called the
a. stated interest rate
b. effective interest rate
c. contract interest rate
d. straight-line rate
ANS: B DIF: 1 OBJ: 03
9. If the market rate of interest is 8%, the price of 6% bonds paying interest semiannually with
a face value of $100,000 will be
a. Equal to $100,000
b. Greater than $100,000
c. Less than $100,000
d. Greater than or less than $100,000, depending on the maturity date of the bonds
10. The present value of $40,000 to be received in one year, at 6% compounded annually, is
(rounded to nearest dollar)
a. $37,736
b. $42,400
c. $40,000
d. $2,400
11. The present value of $30,000 to be received in two years, at 12% compounded annually, is
(rounded to nearest dollar)
a. $23,916
b. $37,632
c. $23,700
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d. $30,000
12. When the market rate of interest on bonds is higher than the contract rate, the bonds will sell
at
a. a premium
b. their face value
c. their maturity value
d. a discount
13. A corporation issues for cash $8,000,000 of 8%, 30-year bonds, interest payable
semiannually. The amount received for the bonds will be
a. present value of 60 semiannual interest payments of $320,000, plus present value
of $8,000,000 to be repaid in 30 years
b. present value of 30 annual interest payments of $640,000
c. present value of 30 annual interest payments of $640,000, plus present value of
$8,000,000 to be repaid in 30 years
d. present value of $8,000,000 to be repaid in 30 years, less present value of 60
semiannual interest payments of $320,000
14. The interest rate specified in the bond indenture is called the
a. discount rate
b. contract rate
c. market rate
d. effective rate
15. The Mansur Company issued $100,000 of 12% bonds on May 1, 2006 at face value. The
bonds pay interest semiannually on January 1 and July 1. The bonds are dated January 1,
2006, and mature on January 1, 2010. The total interest expense related to these bonds for
the year ended December 31, 2006 is
a. $2,000
b. $4,000
c. $8,000
d. 12,000
16. On January 1, 2006, the Queen Corporation issued 10% bonds with a face value of
$100,000. The bonds are sold for $97,000. The bonds pay interest semiannually on June 30
and December 31 and the maturity date is December 31, 2010. Queen records straight-line
amortization of the bond discount. The bond interest expense for the year ended December
31, 2006, is
a. $9,400
b. $9,700
c. $10,000
d. $10,600
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17. If $1,000,000 of 8% bonds are issued at 102 1/2, the amount of cash received from the sale
is
a. $1,080,000
b. $975,000
c. $1,000,000
d. $1,025,000
18. If $3,000,000 of 10% bonds are issued at 97, the amount of cash received from the sale is
a. $3,300,000
b. $3,000,000
c. $3,090,000
d. $2,910,000
19. A corporation issues for cash $1,000,000 of 10%, 20-year bonds, interest payable annually,
at a time when the market rate of interest is 12%. The straight-line method is adopted for
the amortization of bond discount or premium. Which of the following statements is true?
a. The amount of the annual interest expense is computed at 10% of the bond
carrying amount at the beginning of the year.
b. The amount of the annual interest expense gradually decreases over the life of the
bonds.
c. The amount of unamortized discount decreases from its balance at issuance date to
a zero balance at maturity.
d. The amount of unamortized premium decreases from its balance at issuance date to
a zero balance at maturity.
20. If the straight-line method of amortization of bond premium or discount is used, which of
the following statements is true?
a. Annual interest expense will increase over the life of the bonds with the
amortization of bond premium.
b. Annual interest expense will remain the same over the life of the bonds with the
amortization of bond discount.
c. Annual interest expense will decrease over the life of the bonds with the
d. Annual interest expense will increase over the life of the bonds with the
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21. A corporation issues for cash $1,000,000 of 8%, 20-year bonds, interest payable annually, at
a time when the market rate of interest is 7%. The straight-line method is adopted for the
amortization of bond discount or premium. Which of the following statements is true?
a. The carrying amount increases from its amount at issuance date to $1,000,000 at
maturity.
b. The carrying amount decreases from its amount at issuance date to $1,000,000 at
maturity.
c. The amount of annual interest paid to bondholders increases over the 20-year life
of the bonds.
d. The amount of annual interest expense decreases as the bonds approach maturity.
22. A corporation issues for cash $14,000,000 of 8%, 20-year bonds, interest payable annually,
at a time when the market rate of interest is 9%. The straight-line method is adopted for the
amortization of bond discount or premium. Which of the following statements is true?
a. The amount of annual interest paid to bondholders remains the same over the life
of the bonds.
b. The amount of annual interest expense decreases as the bonds approach maturity.
c. The amount of annual interest paid to bondholders increases over the 20-year life
of the bonds.
d. The carrying amount decreases from its amount at issuance date to $14,000,000 at
maturity.
23. The entry to record the amortization of a premium on bonds payable is
a. debit Premium on Bonds Payable, credit Interest Expense
b. debit Interest Expense, credit Premium on Bond Payable
c. debit Interest Expense, debit Premium on Bonds Payable, credit Cash
d. debit Bonds Payable, credit Interest Expense
24. The entry to record the amortization of a discount on bonds payable is

a. debit Discount on Bonds Payable, credit Interest Expense
b. debit Interest Expense, credit Discount on Bonds Payable
c. debit Interest Expense, credit Cash
d. debit Bonds Payable, credit Interest Expense
25. When the market rate of interest was 12%, Newman Corporation issued $1,000,000, 11%,
10-year bonds that pay interest annually. The selling price of this bond issue was
a. $ 321,970
b. $1,000,000
c. $ 943,494
d. $621,524
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26. When the market rate of interest was 11%,Waverly Corporation issued $1,000,000, 12%, 8-
year bonds that pay interest semiannually. The selling price of this bond issue was
a. $1,052,310
b. $1,154387
c. $1,000,000
d. $ 720,495
27. The journal entry a company records for the issuance of bonds when the contract rate and
the market rate are the same is
a. debit Bonds Payable, credit Cash
b. debit Cash and Discount on Bonds Payable, credit Bonds Payable
c. debit Cash, credit Premium on Bonds Payable and Bonds Payable
d. debit Cash, credit Bonds Payable
28. The journal entry a company records for the issuance of bonds when the contract rate is
greater than the market rate would be
29. The journal entry a company records for the issuance of bonds when the contract rate is less
than the market rate would be
30. When the market rate of interest was 11%, Welch Corporation issued $100,000, 8%, 10-year
bonds that pay interest semiannually. Using the straight-line method, the amount of
discount or premium to be amortized each interest period would be
a. $4,000
b. $896
c. $17,926
d. $1,793
31. The journal entry a company records for the payment of interest, interest expense, and
amortization of bond discount is
a. debit Interest Expense, credit Cash and Discount on Bonds Payable
b. debit Interest Expense, credit Cash
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c. debit Interest Expense and Discount on Bonds Payable, credit Cash

d. debit Interest Expense, credit Interest Payable and Discount on Bonds Payable
32. The journal entry a company records for the payment of interest, interest expense, and
amortization of bond premium is
a. debit Interest Expense, credit Cash and Premium on Bonds Payable
b. debit Interest Expense, credit Cash
c. debit Interest Expense and Premium on Bonds Payable, credit Cash
d. debit Interest Expense, credit Interest Payable and Premium on Bonds Payable
33. Sinking Fund Cash would be classified on the balance sheet as
a. a current asset
b. a fixed asset
c. an intangible asset
d. an investment
34. Sinking Fund Investments would be classified on the balance sheet as

a. a current asset
b. a fixed asset
c. an investment
d. a deferred debit
35. The cash and securities comprising a sinking fund established to redeem bonds at maturity
in 2015 should be classified on the balance sheet as
a. fixed assets
b. current assets
c. intangible assets
d. investments
36. The bond indenture may provide that funds for the payment of bonds at maturity be
accumulated over the life of the issue. The amounts set aside are kept separate from other
assets in a special fund called a(n)
a. enterprise fund
b. sinking fund
c. special assessments fund
d. general fund
37. Sinking Fund Income is reported in the income statement as
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a. income from operations

b. extraordinary
c. gain on sinking fund transactions
d. other income
38. If bonds payable are not callable, the issuing corporation
a. cannot repurchase them before maturity
b. can repurchase them in the open market
c. must get special permission from the SEC to repurchase them
d. is more likely to repurchase them if the interest rates increase
39. When callable bonds are redeemed below carrying value

a. Gain on Redemption of Bonds is credited
b. Loss on Redemption of Bonds is debited
c. Retained Earnings is credited
d. Retained Earnings is debited
40. Bonds Payable has a balance of $1,000,000 and Discount on Bonds Payable has a balance of
$12,500. If the issuing corporation redeems the bonds at 98, what is the amount of gain or
loss on redemption?
a. $7,500 loss
b. $34,500 loss
c. $34,500 gain
d. $7,500 gain
41. Bonds Payable has a balance of $900,000 and Premium on Bonds Payable has a balance of
$10,000. If the issuing corporation redeems the bonds at 102, what is the amount of gain or
loss on redemption?
a. $1,100 loss
b. $1,100 gain
c. $8,000 loss
d. $8,000 gain
42. A long-term investment in debt securities is carried at
a. cost
b. lower of cost or market
c. equity
d. market
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43. The amortization of discount on bonds purchased as a long-term investment
a. decreases the amount of interest expense
b. increases the amount of the investment account
c. decreases the amount of the investment account
d. increases the amount of interest expense
44. The amortization of premium on bonds purchased as a long-term investment

a. decreases the amount of interest expense
b. increases the amount of the investment account
c. decreases the amount of the investment account
d. increases the amount of interest revenue
45. On June 1, $400,000 of bonds were purchased as a long-term investment at 97 and $500 was
paid as the brokerage commission. If the bonds bear interest at 12%, which is paid
semiannually on January 1 and July 1, what is the total cost to be debited to the investment
account?
a. $400,000
b. $388,500
c. $400,500
d. $388,000
46. When the bonds are sold for more than their face value, the carrying value of the bonds is
equal to
a. face value
b. face value plus the unamortized discount
c. face value minus the unamortized premium
d. face value plus the unamortized premium
47. The balance in Discount on Bonds Payable
a. should be reported on the balance sheet as an asset because it has a debit balance
b. should be allocated to the remaining periods for the life of the bonds by the
straight-line method, if the results obtained by that method materially differ from
the results that would be obtained by the interest method
c. would be added to the related bonds payable to determine the carrying amount of
the bonds
d. would be subtracted from the related bonds payable on the balance sheet
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48. The balance in Discount on Bonds Payable that is applicable to bonds due in 2015 would be
reported on the balance sheet in the section entitled
a. current liabilities
b. long-term liabilities
c. current assets
d. intangible assets
49. The balance in Premium on Bonds Payable

a. should be reported on the balance sheet as a deduction from the related bonds
payable
b. should be allocated to the remaining periods for the life of the bonds by the
straight-line method, if the results obtained by that method materially differ from
the results that would be obtained by the interest method
c. would be added to the related bonds payable on the balance sheet
d. should be reported in the paid-in capital section of the balance sheet
50. The account Investment in Bonds is reported
a. at cost as a long-term liability along with the current portion reported as a current
liability
b. at cost as a long-term asset less Discount on Bond Investments or plus Premium on
Bond Investments
c. at cost as a long-term asset
d. at fair market value because that is all that is required
51. Any unamortized premium should be reported on the balance sheet of the issuing
corporation as
a. a direct deduction from the face amount of the bonds in the liability section
b. as paid-in capital
c. a direct deduction from retained earnings
d. an addition to the face amount of the bonds in the liability section
52. Debtors are interested in the times-interest-earned ratio because they want to
a. know what rate of interest the corporation is paying
b. have adequate protection against a potential drop in earnings jeopardizing their
interest payments
c. be sure their debt is backed by collateral
d. know the tax effect of lending to a corporation
53. Numbers of times interest charges earned is computed as

a. Income before income taxes plus Interest Expense divided by Interest Expense
b. Income before income taxes less Interest Expense divided by Interest Expense
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c. Income before income taxes divided by Interest Expense

d. Income before income taxes plus Interest Expense divided by Interest Revenue
54. Balance sheet and income statement data indicate the following:
Bonds payable, 8% (issued 1990, due 2015) $1,200,000

Preferred 8% stock, $100 par
(no change during the year) 200,000
Common stock, $50 par
(no change during the year) 1,000,000
Income before income tax for year 320,000
Income tax for year 80,000
Common dividends paid 60,000
Preferred dividends paid 16,000
Based on the data presented above, what is the number of times bond interest charges were
earned (round to two decimal places)?
a. 5.67
b. 4.33
c. 3.24
d. 3.50
55. When the effective-interest method is used, the amortization of the bond premium
a. increases interest expense each period
b. decreases interest expense each period
c. increases interest expense in some periods and decreases interest expense in other
periods
d. has no effect on the interest expense in any period
ANS: B DIF: 2 OBJ: App
56. The Raymore Company issued 10-year bonds on January 1, 2006. The 15% bonds have a
face value of $100,000 and pay interest every January 1 and July 1. The bonds were sold for
$117,205 based on the market interest rate of 12%. Raymore uses the effective-interest
method to amortize bond discounts and premiums. On July 1, 2006, Raymore should record
interest expense (round to the nearest dollar) of
a. $7,032
b. $7,500
c. $8,790
d. $14,065
ANS: A DIF: 3 OBJ: App
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PROBLEM
1. Two companies are financed as follows:
X Co. Y Co.
Bonds payable, 9% issued at face $5,000,000 $3,000,000
Common stock, $20 par 3,000,000 3,000,000
Income tax is estimated at 40% of income.
Determine for each company the earnings per share of common stock, assuming that the
income before bond interest and income taxes is $1,500,000 each.
ANS:
X Co. Y Co.
Earnings before interest and taxes $1,500,000 $1,500,000
Deduct interest on bonds 450,000 270,000
Income before income tax $1,050,000 $1,230,000
Deduct income tax 420,000 492,000
Net income $ 630,000 $ 738,000
========= ==========
=
Earnings per share on common stock $4.20 $4.92
========= ==========
=
DIF: 2 OBJ: 01
2. (a) Prepare the journal entry to issue $200,000 bonds which sold for $195,000.
(b) Prepare the journal entry to issue $200,000 bonds which sold for $204,000.
ANS:
(a)
Cash 195,000
Discount on Bonds Payable 5,000
Bonds Payable 200,000
(b)
Cash 204,000
Premium on Bonds Payable 4,000
Bonds Payable 200,000
DIF: 1 OBJ: 04
3. Doe Co. issued $10,000,000 of 30-year, 8% bonds on May 1 of the current year, with
interest payable on May 1 and November 1. The fiscal year of the company is the calendar
year. Journalize the entries to record the following selected transactions for the current year:
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May 1 Issued the bonds for cash at their face amount.
Nov. 1 Paid the interest on the bonds.
Dec. 31 Recorded accrued interest for two months.

ANS:
May 1 Cash 10,000,000

Bonds Payable 10,000,000
Nov. 1 Interest Expense 400,000

Cash 400,000
Dec. 31 Interest Expense 133,333

Interest Payable 133,333
DIF: 3 OBJ: 04
4. On the first day of the current fiscal year, $1,500,000 of 10-year, 8% bonds, with interest
payable semiannually, were sold for $1,225,000. Present entries to record the following
transactions for the current fiscal year:
(a) Issuance of the bonds.

(b) First semiannual interest payment.
(c) Amortization of bond discount for the year, using the straight-line method of
amortization.
ANS:
(a)
Cash 1,225,000
(b)
Interest Expense 60,000

(c)

DIF: 3 OBJ: 04
5. On the first day of the current fiscal year, $2,000,000 of 10-year, 7% bonds, with interest
payable annually, were sold for $2,125,000. Present entries to record the following
transactions for the current fiscal year:
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(b) First annual interest payment.
(c) Amortization of bond premium for the year, using the straight-line method
of amortization.
ANS:
(a)
Cash 2,125,000
Bond Payable 2,000,000
(b)

Cash 140,000
(c)

DIF: 3 OBJ: 04
6. On August 1, Stuart Co. issued $1,300,000 of 20-year, 9% bonds, dated August 1, for
$1,225,000. Interest is payable semiannually on February 1 and August 1. Present the
entries to record the following transactions for the current year:

(b) Accrual of interest and amortization of bond discount for the year, on
December 31, using the straight-line method.
ANS:
(a)
Cash 1,225,000
(b)

Interest Expense 1562.50

Discount on Bonds Payable 1,562.50
133
DIF: 4 OBJ: 04
7. Present entries to record the selected transactions described below:
(a) Issued $3,250,000 of 10-year, 8% bonds at 97.

(b) Amortized bond discount for a full year, using the straight-line method.
(c) Called bonds at 98. The bonds were carried at $3,175,500 at the time of the
redemption.
ANS:
(a)
Cash 3,152,500
(b)

(c)

Loss on Redemption of Bonds 9,500
Cash 3,185,000
DIF: 4 OBJ: 04, 06
8. A company issued $2,000,000 of 30-year, 8% callable bonds on April 1, 2005, with interest
payable on April 1 and October 1. The fiscal year of the company is the calendar year.
Journalize the entries to record the following selected transactions:
2005
Apr. 1 Issued the bonds for cash at their face amount.
Oct. 1 Paid the interest on the bonds.
2009
Oct. 1 Called the bond issue at 103, the rate provided in the bond indenture. (Omit
entry for payment of interest.)
ANS:
2005
Apr. 1 Cash 2,000,000
Oct. 1 Interest Expense 80,000
134
Cash 80,000
2009
Oct. 1 Bonds Payable 2,000,000
Loss on Redemption of Bonds 40,000
Cash 2,040,000
DIF: 3 OBJ: 04, 06
9. Arthur Corp. issued $2,500,000 of 20-year, 9% callable bonds on July 1, 2005, with interest
payable on June 30 and December 31. The fiscal year of the company is the calendar year.
Journalize the entries to record the following selected transactions:
2005
July 1 Issued the bonds for cash at their face amount.
Dec. 31 Paid the interest on the bonds.
2011
Dec. 31 Called the bond issue at 97, the rate provided in the bond indenture. (Omit
entry for payment of interest.)
ANS:
2005
July 1 Cash 2,500,000
Dec. 31 Interest Expense 112,500

Cash 112,500
2011
Dec. 31 Bonds Payable 2,500,000
Gain on Redemption of Bonds 75,000
Cash 2,425,000
DIF: 3 OBJ: 04, 06
10. On June 30, 2006, Athens Company issued $1,500,000 of 10-year, 8% bonds, dated June 30,
for $1,540,000. The bonds were purchased by Palermo Co. on the issue date at the issue
price. Present entries to record the following transactions:
(a)
Athens Company
(1) Issuance of bonds.
(2) Payment of first semiannual interest on December 31, 2006.
135
(3) Amortization by straight-line method of bond premium on December 31,

2006.
(b)
Palermo Company
(1) Purchase of bonds.
(2) Receipt of first semiannual interest amount on December 31, 2006.
(3) Amortization by straight-line method of bond premium on December 31,
2006.
ANS:
(a)
(1) Cash 1,540,000

(2) Interest Expense 60,000

Cash 60,000
(3) Premium on Bonds Payable 2,000

(b)
(1) Investment in Athens Co. Bonds 1,540,000

Cash 1,540,000
(2) Cash 60,000

Interest Revenue 60,000
(3) Interest Revenue 2,000

Investment in Athens Co. Bonds 2,000
DIF: 4 OBJ: 04, 07
11. Journalize the entries to record the following selected transactions of Owens Co.:
136
(a) Purchased $100,000 of Kelly Co. 8% bonds at 102 plus accrued interest of
$2,000.
(b) Received first semiannual interest payment.
(c) Amortized $40 on the bond investment at the end of the first year.
(d) Sold the bonds at 97 plus accrued interest of $1,500. The bonds were
carried at $101,500 at the time of the sale.
ANS:
(a)
Investment in Kelly Co. Bonds 102,000

Cash 104,000
(b)
Cash 4,000
(c)
Interest Revenue 40
Investment in Kelly Co. Bonds 40
(d)
Cash 98,500
Loss on Sale of Investments 4,500
Investment in Kelly Co. Bonds 101,500
DIF: 4 OBJ: 07
12. Ace Company purchased as a long-term investment $500,000 of Blue Corporation 10-year,
9% bonds. Present entries to record the following selected transactions:
(a) Purchased bonds for $475,000.

(b) Amortized $1,800 of discount on bonds for the year.
(c) Sold bonds at 98 plus accrued interest of $8,000. The broker deducted $400
for brokerage fees and taxes, remitting the balance. The bonds were carried
at $489,000 at the time of the sale.
ANS:
(a)
Investment in Blue Corporation Bonds 475,000

Cash 475,000
(b)
Investment in Blue Corporation Bonds 1,800
137
(c)
Cash 497,600
Investment in Blue Corp. Bonds 489,000
Gain on Sale of Investments 600
DIF: 3 OBJ: 07
13. Indicate the section where each of the following items would be reported on the corporation
balance sheet:
Use the following abbreviations to report the relevant balance sheet section:
CA = Current Assets
I = Investments
PPE = Property, Plant, and Equipment
IA = Intangible Assets
CL = Current Liabilities
LTL = Long-Term Liabilities
PIC = Paid-In Capital
RE = Retained Earnings
(a) Deferred income tax payable (due after current year)

(b) Marketable securities
(c) Bond sinking fund
(d) Excess of issue price over par of common stock
(e) Investment in Adkins Co. bonds
(f) Unamortized bond discount (on bonds due in 2008)
ANS:
(a) LTL
(b) CA
(c) I
(d) PIC
(e) I
(f) LTL
DIF: 3 OBJ: 08
14. Balance sheet and income statement data indicate the following:
Company A Company B
Bonds payable, 8% (issued 1985, due 2009) $1,200,000 $ 900,000
Preferred 5% stock, $100 par
138
(no change during year) 300,000 400,000

Common stock, $50 par
(no change during year) 1,000,000 1,000,000
Income before income tax for year 495,000 130,000
Income tax for year 75,000 12,000
Common dividends paid 50,000 0
Preferred dividends paid 21,000 28,000
(a) For each company, what is the number of times bond interest charges were
earned (round to one decimal place)?
(b) Which company gives potential creditors the most protection?
ANS:
(a) Company A 6.2 Company B 2.8
(b) Company A offers potential creditors the most protection.

DIF: 3 OBJ: 09
139

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CHAPTER 15

BONDS PAYABLE AND INVESTMENTS IN BONDS

Chapter 15—Bonds Payable and Investments in Bonds

ANS: T DIF: 1 OBJ: 03

ANS: F DIF: 1 OBJ: 07

ANS: F DIF: 1 OBJ: 09

ANS: D DIF: 3 OBJ: 04

24. The entry to record the amortization of a discount on bonds payable is

c. debit Interest Expense and Discount on Bonds Payable, credit Cash

34. Sinking Fund Investments would be classified on the balance sheet as

a. income from operations

39. When callable bonds are redeemed below carrying value

ANS: A DIF: 1 OBJ: 07

44. The amortization of premium on bonds purchased as a long-term investment

49. The balance in Premium on Bonds Payable

53. Numbers of times interest charges earned is computed as

c. Income before income taxes divided by Interest Expense

Bonds payable, 8% (issued 1990, due 2015) $1,200,000

Income tax is estimated at 40% of income.

May 1 Issued the bonds for cash at their face amount.

Nov. 1 Paid the interest on the bonds.

Dec. 31 Recorded accrued interest for two months.

May 1 Cash 10,000,000

Nov. 1 Interest Expense 400,000

Dec. 31 Interest Expense 133,333

(a) Issuance of the bonds.

Interest Expense 60,000

Interest Expense 27,500

(a) Issuance of the bonds.

Interest Expense 140,000

Premium on Bonds Payable 12,500

(a) Issuance of the bonds.

Interest Expense 48,750

Interest Expense 1562.50

(a) Issued $3,250,000 of 10-year, 8% bonds at 97.

Interest Expense 9,750

Bonds Payable 3,250,000

Oct. 1 Paid the interest on the bonds.

Oct. 1 Interest Expense 80,000

Dec. 31 Paid the interest on the bonds.

Dec. 31 Interest Expense 112,500

(3) Amortization by straight-line method of bond premium on December 31,

(1) Cash 1,540,000

(2) Interest Expense 60,000

(3) Premium on Bonds Payable 2,000

(1) Investment in Athens Co. Bonds 1,540,000

(2) Cash 60,000

(3) Interest Revenue 2,000

Investment in Kelly Co. Bonds 102,000

(a) Purchased bonds for $475,000.

Investment in Blue Corporation Bonds 475,000

Investment in Blue Corporation Bonds 1,800

Interest Revenue 1,800

(a) Deferred income tax payable (due after current year)

(no change during year) 300,000 400,000

(a) Company A 6.2 Company B 2.8

(b) Company A offers potential creditors the most protection.

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