ACT 205 Lecture Notes - Lecture 20: Sinking Fund

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skykangaroo617

10 Apr 2018

School

CSU

Department

Accounting

Course

ACT 205

Professor

Sally Plasterer Whitney

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Document Summary

*must discount price to get investors to buy. *all investors want to own so the price is bid up. Bond prices are quoted as a percentage of face value ( > 100 premium, < 100. ***as the bond price goes up, the interest rate goes down. Have specific assets pledged as collateral, unsecured bonds do not. May be converted into common stock at the bondholder"s option. Are subject to retirement at a stated dollar amount prior to maturity. *not all bonds are convertible, and not all bonds are callable. Require payment of the full principal amount of the bond at a single maturity date. May require borrower to set up a sinking fund. An investment fund used to set aside money to pay the outstanding debt as it comes due. Require payments in installments over a series of years. Easier for the borrower to meet its bond obligations as they become due. Failure to properly consider risk could prove costly.

Related Questions

Select the best answer from the list below to completestatements that follow.

amortization long-term callable loss contra liability marketface value present value discount premium

1. All liabilities that are not classified as currentliabilities are classified as_____________

. 2. The denomination or principal amount of the bond is usuallyreferred to as the___________

. 3. Bonds that may be retired by the issuing company beforetheir specified due date are________________

. 4. The________________ rate of interest is the rate thatbondholders could obtain by investing in other bonds that aresimilar to the issuing firm's bonds.

5. The bond issue price equals the _______________of the cashflows that the bond will produce.

6. Bonds were issued at a(n)________________ when the issueprice exceeds the face value.

7. Discount on Bonds Payable is shown on the balance sheet asa(n) ________________

. 8. If the market rate ofinterest is greater then the face rate, then the bonds are issuedat a(n) ________________________.

9. ____________________is theprocess of transferring an amount from the bond discount or premiumto interest expense each time period to adjust interestexpense.

10. When a bond is retired earlyand the redemption price is greater than the bond's carrying value,there will be a(n) ______________________ on redemption.

blackmarten837

Consider this question:

Assume that your bond has an interest rate of 10 percent when other bonds are paying 12 percent. Investors will not want to buy your bond if they can earn 12 percent elsewhere. What can you do to get investors to buy your 10 percent bond? (Answer: lower the price)

You will need to drop the price of your bond so investors are really getting a 12 percent return. In other words, you need to drop the price to the present value of the bond using a 12 percent interest rate. You will need to sell the bond at a discount.

The selling price of a bond is determined by the relationship between the bondâs contract interest rate and the market interest rate when the bond is sold.

If contract rate = market rate, bond sells at face value.

If contract rate > market rate, bond sells at a premium.

If contract rate < market rate, bond sells at a discount.

DEMONSTRATION PROBLEM 3 â Issuance of a Bond (Premium)

On January 1, a corporation issued a $1 million, five-year, 11 percent bond that pays interest semiannually. The market interest rate on January 1 was 10 percent. What would be the journal entry to record the issuance of this bond? (The market value of the bond, so you wonât have to calculate it yourself, is $1,038,606).

TRUE OR FALSE?

1. Bondholders are crditors of the issuing corporation.

2. bondholders claims on the assets of the corporation rank aheadof stockholders

3. the prices of bonds are quoted as a percentage of the bonds'market value

4. when the market rate of interest is less than the contract ratefor a bond, the
bond will sell for a premium.

5. an equal stream of periodic payments is called an annuity.

6.one reason a dollar today is worth more than a dollar 1 year fromtoday is the time
value of money.

7. if the straight-line method of amortization is used, the amountof unamortization
premium on bonds payable will decrease as the bonds approachmaturity.

8. if the amount of a bond premium on an issued 11% 4-year,$100,000 bond is $12,928, the amiannual straight-line amortizationof the premium is $1,416.

9. The issue price of zero-coupon bonds is the present value oftheir face amount.

10. if sinking fund cash is used to purchase investments,thoseinvestments are
reported on the balance sheet as marketable securities.

11. callable bonds can be redeemed by the issuing corporation atthe fair market
price of the bonds.

12. if bonds of $1,000,000 with unamortized discount if $10,000 areredeemed at 98,
the gain on redemption of bonds is $10,000

13. Amortization is the allocation process of writing off bondpremiums and discounts to interest expense over the life of thebond issue.

14. the amortization of a premium on bonds payable decreses bondinterest expense.

15. the balance in premium on bonds payable should be reported as adeduction from bonds payable on the balance sheet.

Multiple Choice:
16. one potential advantage of financing corportations through theuse 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 deductable for tax purposes by thecorporation
d.a higher earnings per share is guarenteed for existing commonshareholders

17. when the corporation issuing the bonds has the right torepurchase the bonds prior to the maturity date for a specificprice, the bonds are
a. convertible bonds
b.unsecured bonds
c.debenture bonds
d.callable bonds

18.the present value of $30,000 to be received in 2 years, at 12%compounded annually is (rounded to nearest dollar)
a. $23,916
b.$37,632
c.23,700
d.30,000

19. An unsecured bons is the same as a
a. debenture bond
b. zero coupon bond
c. term bond
d. bond indenture

20. if $1,000,000 of 8% bonds are issued at 102 1/2, the amount ofcash recieved from the sale is
a.$1,080,000
b.$975,000
c.$1,000,000
d.$1,025,000

21. A corporation issues for cash $1,000,000 of 8%,20-year bonds,interest payable annually, at a time when the market rate ofinterest is 7%. the straight-line method is adopted for theamortization of bond discount or premium. which of the following istrue?
a. the carrying amount increases from its amount at issuance dateto $1,000,000 at maturity.
b. the carrying amount decreases from its amount at issuance dateto $1,000,000 at maturity.
c.the amount of annual interest paid to bondholders increases overthe 20-year life of the bonds
d.the amount of annual interest expense decreases as the bondsapproach maturity.

22. When the market rate of interest was 11%, Waverly corporationissued $1,000,000,12%,8-year bonds that pay interest semiannually.the selling price of this bond issue was
a. $1,052,310
b. $1,154,387
c.$1,000,000
d.720,495

23. The journal entry a company records for the issuance of bondswhen the contract rate is less than the market rate would be
a.debit bonds payable, credit cash
b.debit cash and discount on bonds payable, credit bondspayable
c.debit cash, credit premium on bonds payable and bondspayable
d.debit cash, credit bonds payable

24. On januaray 1,2007 the kings corporation issued 10% bonds witha face value of $100,000. the bonds are sold for $96,000. The bondspay interest semiannually on june 30 and december 31 and thematuritydate is december 31,2011. kings records straight-lineamortization of the bond discount. the bond interest expense forthe year ended dec 31,2007 is
a. $9,200
b.$9,800
c.$10,400
d.$10,800

25.If the market rate of interest is 10%, a $10,000, 12%, 10-yearbond that pays interest semiannually would sell at an amount
a.less tha face value
b.equal to face valur
c.greater thand face value
d.that cannot be determined

26. the torrez corporation issue a $1,000, 10-year bonds, 8%,$1,000 bonds dated jan 1,2007 at 97. the journal entry to recordthe issuance will show a
a.credit to discount on bonds payable for $30,000
b.debit to cash of $1,000,000
c.credit to bonds payable for $1,000,000
d.credit to cash for $970,000

27.bonds with a face amount $1,000,000 are sold at 97. the entry torecord the issuance is
a.Cash $1,000,000
Premium on bonds payable $30,000
Bonds Payable &nbÃµns?x.?H?mnbsp;$970,000
b.Cash $970,000
Premium on bonds payable $30,000
bonds payable $1,000,000
c.Cash $970,000
Discount on bonds payable $30,000
Bonds payable $1,000,000
d.Cash $970,000
Bonds Payable $970,000

28. the cash and securities comprising a sinking fund establishedto redeem bonds at maturity in 2015 should be classified on thebalance sheet as
a.fixed asset
b.current asset
c.intangable assets
d.investments

29. 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

silverbee836

ACT 205 Lecture Notes - Lecture 20: Sinking Fund

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