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Question 9: Prepare the necessary journal entries to record thefollowing transactions relating to the long-term issuance of bondsof Sloan Co.:

March 1:

Issued $600,000 face value Sloan Co. second mortgage, 8% bondsfor $654,120, including accrued interest. Interest is payablesemiannually on December 1 and June 1 with the bonds maturing 10years from this past December 1. The bonds are callable at 102.

June 1:

Paid semiannual interest on Sloan Co. bonds. (Use straight-lineamortization of any premium or discount.)

December 1:

Paid semiannual interest on Sloan Co. bonds and purchased$300,000 face value bonds at the call price in accordance with theprovisions of the bond indenture.

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Deanna Hettinger
Deanna HettingerLv2
28 Sep 2019

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On January 1, 2018, Madison Products issued $41.5 million of 6%, 10-year convertible bonds at a net price of $42.45 million. Madison recently issued similar, but nonconvertible, bonds at 98 (that is, 98% of face amount). The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 30 shares of Madison’s no par common stock. Madison records interest by the straight-line method. On June 1, 2020, Madison notified bondholders of its intent to call the bonds at face value plus a 1% call premium on July 1, 2020. By June 30 all bondholders had chosen to convert their bonds into shares as of the interest payment date. On June 30, Madison paid the semiannual interest and issued the requisite number of shares for the bonds being converted. Required:

1. & 2. Prepare the journal entry for the issuance of the bonds by Madison and interest payment for the June 30, 2018. 3. Prepare the journal entries for the June 30, 2020, interest payment by Madison and the conversion of the bonds (book value method).

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 &nbõns?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

Bond Accounting

In December 2014, Rene Cook sat in her cubicle trying to remember what she had learned in business school about bonds and bond accounting. Ms. Cook, a new CPA and special assistant in a training assignment with the company president, had just met with David Lyons, president of Lyons Document Storage Corporation. Interest rates had fallen over recent years and he had asked her to think about the consequences issuing new bonds at a lower rate of interest and using the proceeds to repurchase the higher coupon rate bonds that are currently outstanding. My Lyons had asked Rene to focus on how much the company’s annual interest payments could be reduced, how reported earnings would be affected, and how the refunding would change the company’s financial position as referenced on the balance sheet, if at all.

The Company

The Lyons Company was a family business in the stationary supply business until the document storage opportunity appeared in the early 1990’s. Lyons Document Storage Corporation was incorporated in 1993 to compete in the emerging and rapidly growing industry that provides secure, off-site storage of documents for other corporate customers. The demand for storage was fueled by the need for corporations to retain records of sales contracts, employment records, compliance records, and other documents. The convenience of secure storage and easy recovery in professionally managed warehouses appealed to corporate clients that wanted to save space in their more expensive office buildings. At the same time, the stationary supply business was growing more competitive with the entrance of Staples, Office Depot and Office Max.

The early 2000’s were difficult for Lyons because there were still differences among management about directions and the company’s future. A large competitor, Iron Mountain, was expanding rapidly in the United States and internationally. When the decision to focus on document storage was made, it was imperative to move quickly to secure storage space and transportation equipment. Management decided to fund the company’s growth by issuing debt rather than by issuing additional equity. Lyons had operated conservatively without any long-term debt until it issued bonds in January of 2005. The bonds issued were $10 million in 20-year bonds, offering a coupon rate of 8%, with interest paid semiannually, and sold to yield the 9% market rate of interest at the time.

Current Situation

David Lyons had told Rene Cook that he felt the time might be ripe to refund the 2005 bond issue and replace it with bonds bearing lower interest rates. He had talked with the company’s investment bankers who had told him that $10 million in new 6% bonds with semiannual interest payments could be issued to provide the company with exactly $10 million, not considering underwriting costs and legal fees that were expected to be nominal. The bonds would pay $300,000 of interest every June 30 and December 31 with a payment of $10 million in principal at the end of 10 years. The new interest payments would be $200,000 less each year than those due on the old bonds, which still had 10 years before they would be paid off. To Lyons, that seemed to offer a saving over the old bonds.

The existing bonds had been issued on January 1, 2005 and would be due December 31, 2024. Interest was paid semiannually to holders of the bonds.

Beginning her research, Rene reached for her copy of Lyons Document Storage’s 2013 Annual Report. (See Exhibit 1 for the Liabilities section of the 2013 Annual Report.) She was confused as to why the liability for the $10 million bonds was only $9.3 million at the end of 2013.

To clarify her understanding, Rene called the company’s controller, Eric Petro, and learned that the 2005 bonds had been issued at a discount. Only about $9.1 million was received when the bonds were issued. For further information, Petro referred Rene to footnote 8 of the company’s 2013 financial statements (Exhibit 2).

Next, Rene went to the Internet to determine the market price of the company’s bonds. The current price was shown as 114.88 – reflecting the 6% yield the market for bonds was currently supporting. This meant that each $1,000 bond would have to be repurchased for $1,148.77. The company would have to spend $11.5 million to retire bonds that would be listed on the December 2014 balance sheet at less than $10 million. The resulting loss would shrink the 2015 projected earnings and slow the growth rate in earnings about which David Lyons was so proud. Rene knew this would not make Mr. Lyons happy. However, the lower interest payments associated with the new bonds would help reduce cash outflows in future years.

1. There is no indication in this case that the 2005 bonds were “callable”. Assume that the bonds are callable at 102. That is, there is a 2% call premium over par value. What accounting loss would result if the bonds were called at this price? If the bonds were in fact callable, how would this impact your analysis and recommendation?

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