Multiple Choice: Chapter Thirteen

1. The present value factor at 8% for one period is 0.92593, for two periods is 0.85734, for three periods is 0.79383, for four periods is 0.73503, and for five periods is 0.68058. Given these factors, what amount should be deposited in a bank today to grow to \$100 three years from now?

a. \$100/0.79383

b. \$100/(0.92593/3)

c. (\$100/0.92593 + \$100/0.85734 + \$100/0.79383)

d. \$100 X 0.79383

Answerd. The amount to invest today is the present value of \$100, or \$100 times the present value factor of 0.79383.

2. You are thinking of borrowing \$250,000 to buy a new house. If you are going to finance this purchase at 12% interest per annum, and make 360 level monthly payments to pay off the loan, how much will your payments be?

a. \$250,000/360

b. \$250,000/present value factor for lump sum at 360 months and 1% per period

c. \$250,000/present value factor for annuity of 360 months at 1% per period

d. \$250,000 X present value factor for annuity of 360 months at 1% per period

Answerc. The payment times the present value factor for the stream of payments (1% per month, 36 months) is equal to the loan amount. This is equivalent algebraically to dividing the loan by the present value factor to derive the payment amount.

3. Assume that Kamchatny Vladimir borrowed \$100,000 on January 1 of Year 1, at 5% interest per annum. On December 31, of Year 1, an \$8,000 payment is made. On December 31, of year 2, another \$8,000 payment is made. Using normal assumptions about interest and principal reduction, how much is the unpaid balance of Vladimir's loan after the second payment?

a. \$100,000

b. \$94,000

c. \$93,850

d. \$84,000

Answerc. \$93,850. The first payment is \$5,000 of interest (\$100,000 X .05) and \$3,000 principal reduction. The resulting principal balance for Year 2 is \$97,000; which accrues interest of \$4,850 (\$97,000 X .05). The \$8,000 payment in Year 2 therefore reduces the principal by \$3,150 (\$8,000 - \$4,850) to \$93,850.

4. Bonds payable should be disclosed on the balance sheet.

a. At their face value minus any unamortized premiums.

b. At their face value plus any unamortized premiums.

c. At their maturity value.

d. At their face value.

Answerb. Bonds are disclosed on the balance at their face amount, minus any unamortized discount or plus any unamortized premium.

5. When the contract interest rate for a bond exceeds the effective interest rate of the bond, then:

a. The price of the bond will be equal to the future cash flow associated with the bond.

b. The bond will be issued at a premium.

c. The bond will be issued at a discount.

d. The face value of the bond will fluctuate over its life.

Answer b. The bond would be issued at a premium because the contract yield is superior to the going rate of interest for similar bonds. The price of the bond will be less than the future cash flow (it will be equal to the present value of the future cash flow). The face value of a bond does not change over time.

6. On June 1, Surge Corporation issued \$100,000 of 9%, 5-year bonds. The bonds are dated June 1, 20X1. The bonds were issued at 96, and pay interest on December 1 and June 1. The entry to record issuance of the bonds is:

 a. Cash 100,000 Bonds Payable 100,000 b. Cash 96,000 Discount on Bonds Payable 4,000 Bonds Payable 100,000 c. Cash 104,000 Bond Interest Payable 4,000 Bonds Payable 100,000 d. Cash 96,000 Bond Interest Expense 4,000 Bonds Payable 100,000

Answerb. The bonds were issued at a \$4,000 discount. Choice "b" is the only choice which reflects this fact.

7. On April 1, 20X1, German Corporation issued \$100,000 of 7%, 5-year bonds dated April 1, 20X1, at 101. Interest is paid on March 31 and September 30. The proper entries to record bond interest expense for the (entire) year ended 20X1 would include a decrease in interest expense for premium amortization in the amount of (round to the nearest dollar and assume straight-line amortization):

a. \$0

b. \$117

c. \$150

d. \$200

Answerc. \$150. The monthly amortization is \$16.67 (\$1,000/60 months). The total amortization is \$150 (\$16.67 X 9 = \$150).

8. Jeske Company issued \$1,000,000 of 8% bonds at a time when the market rate of interest was 10%. If the bonds were issued at a \$50,000 discount and interest was paid annually, how much was interest expense for the first full year of the bond issue (utilize the effective-interest amortization technique)?

a. \$76,000

b. \$80,000

c. \$95,000

d. \$100,000

Answerc. \$95,000. The bonds' carrying value (\$1,000,000 - \$50,000) times the effective interest rate (10%) yields the total interest expense.

9. When interest payment dates on a bond are June 1 and December 1, and the bond is sold on July 1, the amount of cash received at issuance will be:

a. Decreased by accrued interest from July 1 to December 1.

b. Decreased by accrued interest from June 1 to July 1.

c. Increased by accrued interest from July 1 to December 1.

d. Increased by accrued interest from June 1 to July 1.

Answerd. Bonds issued between interest dates require that the issuer receive the accrued interest relating to the time period from the date of the bond issue (or previous interest payment date in some cases) to the actual effective issue date.

10. Billings Corporation retired \$1,000,000 face of bonds payable. At the time of the retirement, the bonds had unamortized discount of \$20,000, and all interest accruals and payments were current. Under the outstanding covenants, Billings was required to pay the bond holders 103.

a. The transaction caused Billings to recognize a loss of \$50,000.

b. The transaction caused Billings to recognize a gain of \$50,000.

c. The transaction caused Billings to recognize a loss of \$30,000.

d. The transaction caused Billings to recognize a gain of \$20,000.

Answera. Billings would report of a loss of \$50,000. In simple terms, the transaction requires Billings to pay out \$1,030,000 to retire debt that is carried at \$980,000 (\$1,000,000 - \$20,000 unamortized discount). In journal entry form, a \$50,000 debit (loss) would be needed to balance the entry that is necessary to remove the bond payable (\$1,000,000 debit to remove), unamortized discount (\$20,000 credit to remove), and cash (\$1,030,000 credit to reduce).