Compound Financial Instruments

Felix L. Domingo, CPA, CMA

Bond
➢ A formal unconditional promise, made under seal, to pay a specified sum of money at a
determinable future date, and to make periodic interest payment at a stated rate until the
principal sum is paid.

➢ A contract of debt whereby one party called the issuer borrows funds from another party
called the investor.
• A bond is evidenced by a certificate and the contractual agreement between the issuer
and investor is contained in a document known as ‘’bond indenture’’.

Features of bond issue

a. A bond indenture or dead of trust is the document which shows in detail the terms of the loan
and the rights and duties of the borrower and other parties to the contract.
b. Bond certificates are used. Each bond certificate represents a portion of the total loan. The
usual minimum denominations may be issued occasionally.
c. If property is pledged as security for the loan, a trustee is named to hold title to the property
serving as security. The trustee acts as the representative of the bondholders and is usually a
bank of trust entity.
d. A bank or trust entity is usually appointed as registrar or disbursing agent. The borrower
deposits interest and principal payments with the disbursing agent, who then distributes the
funds to the bondholders.

Contents of bond indenture

The bond indenture is the contract between the bondholders and the borrower or issuing entity.
Normally, the bond indenture contains the following items:
a. Characteristics of the bonds
b. Maturity date and provision for the repayment
c. Period of grace allowed to issuing entity
d. Establishment of a sinking fund and the periodic deposit therein
e. Deposit to cover interest payments
f. Provisions affecting mortgaged property, such as taxes, insurance coverage, collection of
interest or dividends on collaterals
g. Access to corporate books and records of trustee
h. Certification of bonds by trustee
i. Required debt to equity ratio
j. Minimum working capital to be maintained, if any..

Types of bonds
A. Term and serial bonds
1) Term bonds are bonds with a single date of maturity. Term bonds may require the issuing
entity to establish a sinking fund to provide adequate money to retire the bond issue at one
time.

2) Serial bonds are bonds with series of maturity dates instead of a single one. In other words,
serial bonds allow the issuing entity to retire the bonds by installments.

B. Secured and unsecured bonds

1) Mortgage bonds are bonds secured by a mortgage on real properties.
➢ These bonds may be first mortgage bonds or bonds with senior claims on entity assets,
or second mortgage bonds or bonds with subordinated claims on entity assets.

2) Collateral trust bonds are bonds secured by stocks and bonds of other corporation.

3) Debenture bonds are bonds without collateral security. These bonds are unsecured and
therefore rank as general creditors in the preference of credits.
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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

C. Registered and bearer bonds

1) Registered bonds require the registration of the name of the bondholders on the books of
the corporation.
➢ If the bondholder sells a bond, the old bond certificate is surrendered to the entity and
a new bond certificate is issued to the buyer. Interest is periodically paid by the issuing
entity to bondholder of record.

2) Coupon or bearer bonds are unregistered bonds in the sense that the name of the
bondholder is not recorded on the entity books.
➢ The issuing entity does not maintain a record of who owns the bonds at any point in
time. Thus, interest on coupon bond is paid to the person submitting in detachable
interest coupon.

D. Other types of bonds

1) Convertible bonds are bonds that can be exchanged for shares of the issuing entity.
2) Callable bonds are bonds which may be called in for redemption prior to the maturity date.
3) Guaranteed bonds are bonds issued whereby another party promises to make payment if
the borrower fails to do so.
4) Junk bonds are high-risk, highly-yield bonds issued by entities that are heavily indebted or
otherwise in weak financial condition.

Initial measurement of bonds payable

➢ In accordance with PFRS 9, paragraph 5.1.1, bonds payable not designated at fair value
through profit or loss shall be measured initially at fair value or present value of the future
cash payments to settle the bond liability minus transaction costs that are directly
attributable to the issue of the bonds payable.

Bond issue costs

➢ Bond issue cost or ‘’transaction cost’’ are incremental cost that are directly attributable to
the issue of bonds payable.
• Such costs include printing and engraving cost, legal and accounting fee, registration fee
with regulatory authorities, commission paid to agents and underwriters and other similar
charges.

➢ Under PFRS 9, bond issue costs shall be deducted from the fair value or issue price of bonds
payable in measuring initially the bonds payable.
• Under the effective interest method of amortization, the bond issue cost must be
‘’lumped’’ with the discount on bonds payable and ‘’netted’’ against the premium on
bonds payable.
• However, if the bonds are measured at fair value through profit or loss, the bond issue
costs are expensed immediately.

Bond issue costs, if the bond is designated as:

➢ Fair value through other comprehensive income (FVOCI), deducted from the fair value or
issue price of the bonds payable

➢ Fair value through profit or loss (FVPL), are treated as expense immediately
• Actually, the fair value of the bonds payable is the same as the issue price or net
proceeds from the issue of the bonds, excluding accrued interest.

Subsequent measurement of bonds payable

➢ In accordance with PFRS 9, paragraph 5.3.1, after initial recognition, bonds payable shall be
measured either:
a. At amortized cost, using effective interest method
b. At fair value through profit or loss

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Amortized cost of bonds payable

➢ The “amortized cost’’ of bonds payable is the amount at which the bond liability is measured
initially minus principal repayment, plus or minus the cumulative amortization using the
effective interest method of any difference between the initial amount and the maturity amount.
• Simply stated, the difference between the face amount and present value of the bonds
payable is amortized using the effective interest method.
• Actually, the difference between the face amount and present value either discount or
premium on the issue of the bonds payable.

Accounting for issuance of bonds

There are two approaches in accounting for the authorization and issuance of bonds, namely:
a. Memorandum approach – In this approach, no entry is made upon the authorization of the
entity to issue bonds. Authorized bonds payable account is not maintained.
b. Journal entry approach – In this approach, as the title suggests, a journal entry is made to
record the authorized bonds payable.

Recording interest on bonds

Accounting for interest expense on bonds requires recognition of two items, namely:
a. Payment of interest during the year
b. Accrual of interest at the end of the year
• Of course, the items are in addition to the proper amortization of premium on bonds
payable and discount on bonds payable as discussed previously.

Bond retirement on maturity date

➢ To make a bond issue more attractive, an entity may agree in the bond indenture to establish
a sinking fund exclusively for use in retiring the bonds at maturity. The periodic cash deposits
plus the interest earned on sinking fund securities should cause the fund to approximately
equal the amount of bond issue on maturity date. When the bonds approach maturity date, the
trustee sells the securities and uses the sinking fund cash to pay bondholders. Any excess
cash is returned to the issuing entity.

➢ Sinking fund or redemption fund is a fund set aside for the liquidation of long-term debt, more
particularly bonds payable. As a rule, sinking fund is classified as a noncurrent investment.
• However, if the related bond payable is due to be settle within twelve months after the
end of the reporting period, the sinking fund shall be classified as current asset because
the bond payable is also reclassified as current liability.
• The classification of a cash fund shall parallel the classification applied to the related
liability.

➢ When bonds are paid on the date of maturity date, no accounting problems are encountered.
• This would simply require the cancellation of the bonds payable at face amount and of
course, the payment of the accrued interest on the date of maturity.

Bond retirement to maturity date

➢ When bonds are reacquired prior to maturity date, they may be canceled and permanently
retired, or held in the treasury for future reissue when the need for fund arises.
• The retirement of bonds prior to maturity date may present some complex
accounting problems.

If the reacquired bonds are canceled and permanently retired, the following procedures are
followed.
1. The bond premium or bond discount should be amortized up to the date of retirement.
2. The balance of the bond premium or bond discount should be determined. This balance is
important because the amount related to the bonds retired is canceled.
3. The accrued interest to date of retirement should be determined.

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

4. The total cash payment should be computed. This is equal to the retirement price plus the
accrued interest. The retirement price is a certain percent of the face amount of the bonds.
5. The carrying amount of the bonds retired is determined. The face amount of the bonds plus
the unamortized premium or minus the unamortized discount gives the carrying amount of the
bonds.
6. The gain or loss on the retirement of the bonds is computed.
a. This is the difference between the retirement price and the carrying amount of the bonds.
b. If the retirement price is more than the carrying amount of the bonds, there is loss.
c. If the retirement price is less than the carrying amount of the bonds, there is gain.
7. The retirement of the bonds is then recorded by canceling the bond liability together with the
unamortized premium or discount. Any accrued interest is debited to interest expense.

Treasury bonds
➢ Treasury bonds are an entity’s own bond originally issued and reacquired but not canceled.
The acquisition of treasury bonds calls for the same accounting procedures accorded to a
formal retirement of bonds prior to the maturity date.
• In other words, the treasury bonds should be debited at face amount and any related
unamortized premium or discount should be canceled. Any accrued interest paid is
charged to interest expense.
• The difference between the acquisition cost and the carrying amount of the treasury
bond is treated as gain or loss on the acquisition of treasury bonds.

Amortization of bond discount or premium

➢ There are three approaches in amortizing bond premium or bond discount, namely:
a. Straight line
b. Bond outstanding method
c. Effective interest method or simply ‘’interest method’’ or scientific method

➢ PFRS 9 provides that after initial recognition, an entity shall measure all financial liabilities
either at amortized cost using the effective interest method or at a fair value through profit or
loss.
• In other words, the standard requires the use of the effective interest method in
amortizing discount, premium and bond issue cost.

➢ Under USA GAAP, APB Opinion No. 21 provides that the straight line method and bond
outstanding method are acceptable if the periodic interest expense is not materially different
from the amount obtained by using the effective interest method.

Effective interest method or scientific method or interest method, distinguishes two kinds of interest:
1. Nominal rate
2. Effective rate
• The nominal rate is the coupon or stated rate; the rate that used to compute for the
periodic interest payment for bond payable.
• The effective rate is the yield or market rate; the rate that is used to compute the
periodic interest expense for bond payable.

Note:
➢ When the bonds are sold at face value, the nominal rate is equal to the effective rate;
➢ When the bonds are sold at a premium, the nominal rate is greater/higher than the effective
rate
➢ When the bonds are sold at a discount, the nominal rate is less/lower than the effective rate

Market price or issue price of Bond Payable

➢ Is equal to the present value of the principal bond liability plus the present value of future
interest payments using the effective rate.

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

➢ Or computed as follows:
Principal Liability multiply by PV of 1 at effective interest rate for “n” Periods
Add: Periodic Nominal Interest multiply by PV of ordinary annuity of 1 at effective interest
rate for “n” Periods
Equals: Present value of Bond Payable

❖ Note: If the interest is paid annually, “n” Periods are equal to maturity period.
If the interest is paid semi-annual, “n” Periods are equal to maturity period
multiply by 2.

Present Value of Serial Bond Payable

Principal Interest Total PV Present

Date Payment Payment Payment Factor Value
1/1/20x1 xxx
12/31/20x1 xxx xxx xxx xxx xxx
12/31/20x2 xxx xxx xxx xxx xxx
Total Present Value xxx
less: Face Value of the Bond Payable (xxx)
(Discount) or Premium on Bond Payable xxx

Effective Interest Method: Procedure:

1. First row is the date of the initial measurement of the bonds payable.
2. Succeeding rows:
a. Date – is the periodic payment of interest, amortization of the discount or premium
b. Interest paid – Face Value multiply by nominal rate
c. Interest expense – Carrying value multiply by effective rate
d. Amortization – the difference between the interest paid and the interest expense
e. Carrying amount – preceding carrying value plus (discount) or minus (premium)
amortization

The schedule of amortization may appear as follows:

Interest Paid Interest Expense Amortization Carrying
Date (using Nominal Rate) (using Effective Rate) (Discount/Premium) Value
1/1/20x1 xxx
12/31/20x1 xxx xxx xxx xxx
12/31/20x2 xxx xxx xxx xxx

Effective Interest Method – Bond Issue Cost

➢ Under PFRS 9, transaction costs that are directly attributable to the issuance of a financial
liability shall be included in the initial measurement of the financial liability.
• The calculation of effective interest rate shall include all transaction costs, discounts and
premiums.

• Under the effective interest method, bond issue cost must be lumped with the discount
and netted against the premiums of the bonds payable. The bond issue costs will
increase the discount and will decrease the premium of bonds payable.

The inclusion of bond issue cost at the initial measurement of bonds payable has the following
effect:
1. If bond is issued at a discount, the original effective interest rate is lower than the new
effective rate.
2. If bond is issued at a premium, the original effective interest rate is higher than the new
effective rate.

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

❖ The new effective rate cannot be computed algebraically but by means of trial and error
or by interpolation process.

Financial Instruments
➢ PAS 32, paragraph 11, defines a financial instruments as any contract that gives rise to both
financial asset of one entity and a financial liability or equity instrument of another entity.
❖ Note that most of financial instruments involve one party having contractual right to
receive cash or another financial asset and another party having a contractual obligation
to deliver cash or another financial asset.

Compound Financial Instruments

➢ PAS 32, paragraph 28, defines a compound financial instrument as “a financial instrument that
contain both a liability and an equity elements from the perspective of the issuer.”
• Common example:
a. Bonds payable issued with share warrants
b. Convertible bonds payable

➢ If a financial instrument contains both a liability and equity components, PAS 32 mandates that
such components shall be accounted for separately.
• This means that the consideration received from the issuance of the compound financial
instruments shall allocated between the liability and equity components.
• The fair value of the liability components is first determined and then deducted to the
total consideration received; the residual amount is allocated to the equity components.

Bonds payable issued with share warrants

➢ When the bonds are sold with share warrants, the bondholders are given the right to acquire
shares to the issuing entity at a specified price at some future time.
• Share warrants attached to a bond may be:
a. Detachable
b. Nondetachable
• Detachable warrants can be traded separately from the bond while the non-detachable
warrants cannot.
• PAS 32, does not differentiate whether the equity components is detachable or non-
detachable, the warrants have a value and therefore shall be accounted for separately.

Allocation of issue price

a. The bonds are assigned an amount equal to the “market value of the bonds ex-warrants”,
regardless of the market value of the warrants. The residual amount of the issue price shall
then be allocated to the warrants.
b. If the “market value of the bonds ex-warrants” is unknown, the amount allocated to the
bonds is equal to the present value of the principal bond liability plus the present value of the
future interest payments using the effective interest rate for similar bonds without warrants.

Convertible bonds
➢ Convertible bonds are those which give the holder the right to convert their bondholding into
share capital or other securities of the issuing entity within specified period of time.
• When convertible bonds are issued at a premium or discount, amortization period is up
to the maturity date instead of the conversion date because it is impossible to predict, if
at all, that the conversion privilege will be exercise.

➢ Accounting problems arise in two situations, namely:

a. When the convertible bonds are originally issued
b. When the convertible bonds are converted

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Original issuance – Allocation of issue price

a. The bonds are assigned an amount equal to the market value of the bonds without the
conversion privilege.
b. It he market value of bonds without the conversion privilege is unknown, the amount
allocated to the bonds is equal to the present value of the principal bond liability plus the
present value of the future interest payments using the effective interest rate for similar
bonds without the conversion privilege.
c. The residual amount of the issue price shall be allocated to the conversion privilege or equity
components.

Conversion of bonds
➢ If the bonds converted into share capital of the issuing entity, the accounting problem is the
determination of a value to be assigned to the share capital issued.

➢ Application Guidance 32 of PAS 32 provides that on conversion of convertible instruments at

maturity, the entity derecognizes the liability components and recognizes it as equity. There is
no gain or loss on conversion at maturity.
• The carrying amount of the bonds, are equal to the face value plus accrued interest if
note paid, plus unamortized premium or minus unamortized discount and bind issue
cost, is the measure of the share capital issued because the carrying amount is the
“effective price” for the shares issued as a result of the conversion.
• Any cost incurred in connection with the bond conversion shall be deducted from share
premium, if any. Otherwise, the cost incurred is treated as expense.

The following points should be considered upon conversion:

a. The amortization of discount and issue cost or premium up to the date of conversion shall be
recorded.
b. The face of the bond converted shall be cancelled together with the related unamortized
premium or discount and bond issue cost.
❖ If only a portion of the bonds is converted, the unamortized premium or discount and
bond issue cost balance shall be cancelled proportionately.
c. Normally, conversion is at an interest date. When at other dates, the accrued interest up to
the date of conversion is ordinary paid.
❖ It the interest is not paid, it is added to the face value of the bonds converted to get
the carrying amount of the bonds for conversion purposes. The accrued interest is
charged to interest expense.
d. The share premium or residual amount from conversion privilege is cancelled upon
conversion because this would effectively form part of the total consideration received for the
shares ultimately issued as a result of the conversion.

If only a portion of the bonds is converted, the equivalent portion of the share premium from
conversation privilege will be cancelled or reclassified to share premium - issuance.

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Problems - Multiple Choices:

Pre-issuance interest
1. On April 1, 20x3, A Co. issued 12%, ₱4,000,000 bonds dated January 1, 20x3 at 97 including
accrued interest. The bonds mature in ten years and pay interest annually every year-end.
How much is the initial carrying amount of the bonds?
a. 3,760,000 b. 3,880,000 c. 4,000,000 d. 3,812,341

➢ Answer (a) is correct.

Cash proceeds including accrued interest (4M × 97%) 3,880,000
less: Accrued interest sold (4M × 12% × 3/12) (120,000)
Carrying amount of the bonds, April 1, 20x1 3,760,000

2. On April 1, 20x3, A Co. issued 12%, ₱4,000,000 bonds dated January 1, 20x3 at 97 excluding
accrued interest. The bonds mature in ten years and pay interest annually every year-end.
How much is the initial carrying amount of the bonds?
a. 3,760,000 b. 3,880,000 c. 4,000,000 d. 3,812,341

➢ Answer (b) is correct. Cash proceeds of 3,880,000 (4,000,000 × 97).

Issue price of bonds - issuance on interest date

3. A Co. is contemplating on issuing a 12%, 3-year, ₱4,000,000 bonds. Principal is due at
maturity but interest is due annually at each year-end. A determines that the current market
rate on January 1, 20x3 is 10%. How much is the estimated issue price of the bonds assuming
A issues bonds on January 1, 20x3?
a. 4,198,948 b. 4,183,744 c. 4,303,920 d. 4,404,314

➢ Answer (a) is correct.

PV of 1 at 10% for 3 periods 0.751315
PV of Ordinary Annuity of 1 at 10% for 3 periods 2.486852

PV of Principal (4,000,000 × .751315) 3,005,260

PV of Interest (480,000 × 2.46685) 1,193,689
Bonds issue price 4,198,949

Issue price of bonds - issuance in between interest dates

4. Use the same information in the preceding problem except that A plans to issue the bonds on
April 1, 20x3. How much is the estimated total proceeds from the issuance of the bonds on
April 1, 20x3?
a. 4,198,948 b. 4,183,744 c. 4,303,921 d. 4,404,314

➢ Answer (c) is correct.

Carrying value - Apr 1, 20x3* 4,183,923
Accrued Interest (4,000,000 × 12% × 3/12) 120,000
Total proceeds 4,303,923

Effective interest method to compute the carrying value as of Apr 1, 20x3

Interest Interest
Premium Carrying
Date Payment expense
Amortization Value*
(12%) (10%)
Jan 1, 20x3 4,198,949
Apr 1, 20x3 120,000 104,974 15,026 4,183,923

Retirement of bonds - Bond refunding

5. On September 30, 20x3, B Co. issued new bonds with face amount of ₱10M for net issuance
proceeds of ₱43,200,000. B used the proceeds to retire an existing 10-year, 12%,
₱32,000,000 bonds issued five years earlier. The bonds have an unamortized discount of
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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

₱1,360,000 as of September 30, 20x3. B reacquired the entire outstanding bonds at a call
premium of ₱1,600,000. Costs incurred that are directly attributable to the retirement
amounted to ₱200,000. B has an income tax rate of 30%. How much is the gain (loss) on the
retirement of the bonds to be recognized in 20x3?
a. 3,160,000 b. (2,960,000) c. 2,960,000 d. (3,160,000)

➢ Answer (d) is correct.

Bonds payable 32,000,000
less: Discount on Bonds Payable (1,360,000)
Carrying value of bonds payable 30,640,000
less: Settlement amount
Cash 32,000,000
Reacquired call premium 1,600,000
Cost incurred in bonds retirement 200,000 (33,800,000)
Loss on extinguishment of the bonds (3,160,000)

Retirement of bonds
6. On January 1, 20x1, A Co. issued 5-year, 12%, ₱4,000,000 bonds for ₱4,303,264. Principal is
due at maturity but interests are due annually. The effective interest rate is 10%. On July 1,
20x3, A called in the entire bonds and retired them at 102. The retirement price includes
payment for any accrued interest. How much is the gain (loss) on the extinguishment of the
bonds?
a. 328,897 b. (328,896) c. (118,948) d. 118,948

➢ Answer (a) is correct.

Interest Interest
Payment Expense Premium Carrying
Date (12%) (10%) Amortization Amount
1/1/20x1 4,303,264
12/31/20x1 480,000 430,326 49,674 4,253,590
12/31/20x2 480,000 425,359 54,641 4,198,949
7/1/20x3 240,000 209,947 30,053 4,168,897

Bonds payable - Jul 1, 20x3 4,168,897

add: Accrued interest (Jan1 to Jun 30) 240,000
Carrying Amount 4,408,897
less: Bonds payable call price (4,000,000 × 102%) (4,080,000)
Gain on the extinguishment of the bonds 328,897

Serial bonds – issued at discount

7. On January 1, 20x3, B Co. issued 10%, ₱12,000,000 bonds for ₱11,601,220. Principal on the
bonds matures in three equal annual installments. Interest is also due annually at each year-
end. The effective interest rate on the bonds is 12%. How much is the carrying amount of the
bonds on December 31, 20x3?
a. 7,844,635 b. 7,793,366 c. 7,683,343 d. 7,543,341

➢ Answer (a) is correct. Effective interest method

Interest Interest
Discount Principal Carrying
Date Payment expense
Amortization Payment Value*
(10%) (12%)
Jan 1, 20x3 11,601,220
Dec 31, 20x3 1,200,000 1,392,146 192,146 4,000,000 7,793,366

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Interest on
Principal Interest Total
Date outstanding
payments payments payments
principal balance
Dec. 31, 20x1 4,000,000 12,000,000 × 10% 1,200,000 5,200,000
Dec. 31, 20x2 4,000,000 8,000,000 × 10% 800,000 4,800,000
Dec. 31, 20x3 4,000,000 4,000,000 × 10% 400,000 4,400,000

Adjustment to effective interest – serial bonds

8. On January 1, 20x3, B Co. issued 10%, ₱12,000,000 bonds at 105. Transaction costs incurred
amounted to ₱177,096. Principal on the bonds mature in three equal annual installments.
Interest payments are also made annually at each year-end. How much is the carrying amount
of the bonds on December 31, 20x3?
a. 8,793,368 b. 8,312,341 c. 8,844,635 d. 8,216,735

➢ Answer (d) is correct.

Issued price (12,000,000 × 105%) 12,600,000
less: Bonds issue costs (177,096)
Net proceeds of Bonds 12,422,904

Trial and error for effective interest rate:

At 9%
PV of 1
Interest on PV of
Principal Interest Total at 9%
Date outstanding Annual
payments payments payments for 3
principal balance Payment
periods
Dec. 31, 20x3 4,000,000 12,000,000 × 10% 1,200,000 5,200,000 0.91743 4,770,636
Dec. 31, 20x4 4,000,000 8,000,000 × 10% 800,000 4,800,000 0.84168 4,040,064
Dec. 31, 20x5 4,000,000 4,000,000 × 10% 400,000 4,400,000 0.77218 3,397,592
Present value of Bonds 12,208,292
Carrying value of Bonds 12,422,904
PV < CV

At 8%
PV of 1
Interest on PV of
Principal Interest Total at 8%
Date outstanding Annual
payments payments payments for 3
principal balance Payment
periods
Dec. 31, 20x3 4,000,000 12,000,000 × 10% 1,200,000 5,200,000 0.92593 4,814,815
Dec. 31, 20x4 4,000,000 8,000,000 × 10% 800,000 4,800,000 0.85734 4,115,226
Dec. 31, 20x5 4,000,000 4,000,000 × 10% 400,000 4,400,000 0.79383 3,492,862
Present value of Bonds 12,422,903
Carrying value of Bonds 12,422,904
PV = CV

Carrying amount of bonds on December 31, 20x3:

Interest Interest Discount Principal Carrying
Date
Payment (10%) expense (8%) Amortization Payment Value*
Jan 1, 20x3 12,422,904
Dec 31, 20x3 1,200,000 993,832 (206,168) 4,000,000 8,216,736

Issue price of serial bonds – acquisition on interest date

9. On January 1, 20x3, A Co. contemplates on issuing 10%, ₱12,000,000 bonds. Principal on the
bonds will mature in three equal annual installments. Interests on the outstanding principal
balance are also payable annually at each year-end. The effective interest rate as of January
1, 20x3 is 12%. How much is the estimated issue price of the bonds on January 1, 20x3?

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 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

a. 11,601,221 b. 8,745,328 c. 9,645,328 d. 10,314,374

➢ Answer (a) is correct.

Interest on PV of 1 at PV of
Principal Interest Total
Date outstanding 12% for 3 Annual
payments payments payments
principal balance periods Payment
Dec. 31, 20x3 4,000,000 12,000,000 × 10% 1,200,000 5,200,000 0.892857 4,642,856
Dec. 31, 20x4 4,000,000 8,000,000 × 10% 800,000 4,800,000 0.797194 3,826,531
Dec. 31, 20x5 4,000,000 4,000,000 × 10% 400,000 4,400,000 0.711780 3,131,833
11,601,221

Issue price of serial bonds – in between interest dates

10. Use the same information in the preceding problem but assume A Co. issues bonds on
September 30, 20x3. How much is the total cash proceeds from the issuance of the bonds on
September 30, 20x3?
a. 11,601,220 b. 8,745,328 c. 9,645,331 d. 10,314,374

➢ Answer (c) is correct.

Bonds Carrying Value - Sep 30, 20x1 8,745,331
add: Accrued interest (1,200,000 × 9/12) 900,000
Net proceeds of Bonds 9,645,331

Interest Interest
Premium Principal Carrying
Date Payment expense
Amortization Payment Value*
(10%) (12%)
Jan 1, 20x3 11,601,221
Sep 30, 20x3 900,000 1,044,110 144,110 3,000,000 8,745,331

Zero-coupon bonds
11. On January 1, 20x3, PAGEANT SHOW Co. issued 10%, ₱12,000,000 bonds at a yield to
maturity interest of 18%. Principal and interest are due on December 31, 20x3. How much is
the carrying amount of the bonds on initial recognition?
a. 15,972,000 b. 9,721,052 c. 9,028,341 d. 9,183,273

➢ Answer (b) is correct.

PV of 1 at 18% for 3 periods 0.608631
PV of Principal (15,972,000 × .608631) 9,721,054

Interest on
Interest Outstanding
Date outstanding
payments Balance
principal balance
Jan 1, 20x3 12,000,000
Dec. 31, 20x3 12,000,000 × 10% 1,200,000 13,200,000
Dec. 31, 20x4 13,200,000 × 10% 1,320,000 14,520,000
Dec. 31, 20x5 14,520,000 × 10% 1,452,000 15,972,000

Issue of convertible bonds

12. On January 1, 20x1, B Co. issued its 10%, 3-year, ₱4,000,000 convertible bonds for the face
amount of ₱4,000,000. Each ₱4,000 bond is convertible into 8 shares with par value of ₱400
per share. When the bonds were issued, they were selling at 98 without the conversion option.
B incurred ₱200,000 transaction costs on the issue of the bonds. How much is the equity
component of the compound instrument?
a. 80,000 b. 200,000 c. 76,000 d. 123,489

➢ Answer (c) is correct.

Issue price 4,000,000
pg. 11
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

less: FV of Debt Instruments (4,000,000 × 98%) (3,920,000)

Residual Amount (Equity Components) 80,000

Allocated amounts Allocation of

Component from issue price Fraction transaction costs Net Proceeds
Debt component 3,920,000 3,920/4,000 196,000 3,724,000
Equity component 80,000 80/4,000 4,000 76,000
4,000,000 4,000/4,000 200,000 3,800,000

Conversion of convertible bonds

13. On January 1, 20x1, A Co. issued its 10%, 3-year, ₱4,000,000 convertible bonds at 105. Each
₱4,000 bond is convertible into 8 shares with par value per share of ₱400. Principal is due on
December 31, 20x3 but interests are due annually at each year-end. When the bonds were
issued, they were selling at a yield to maturity market rate of 12% without the conversion
option. On December 31, 20x2, all of the bonds were converted into equity. Conversion costs
incurred amounted to ₱80,000.

How much is the net increase in equity on December 31, 20x2 due to the conversion of the
bonds?
a. 3,392,148 b. 3,234,998 c. 3,894,759 d. 3,848,571

➢ Answer (d) is correct.

PV of 1 at 12% for 3 periods 0.71178025
PV of ordinary annuity of 1 at 12% for 3 periods 2.40183128

Issue price (4,000,000 × 105%) 4,200,000

less: FV of Debt Instruments
PV of Principal (4,000,000 × .711780) 2,847,121
PV of Interest (400,000 × 2.401831) 960,733 (3,807,853)
Residual amount (Equity components) 392,147

Share Capital {[(4,000,000 ÷ 4,000) × 8] × 400} 3,200,000

Share premium [(3,928,529 - 3,200,000) - 80,000) 648,571
Net increase in equity on December 31, 20x2 3,848,571

Interest payment Interest expense Discount Present

Date
(10%) (12%) Amortization value
Jan. 1, 20x1 3,807,853
Dec. 31, 20x1 400,000 456,942 56,942 3,864,796
Dec. 31, 20x2 400,000 463,776 63,775 3,928,571

Partial conversion of convertible bonds

Use the following information for the next two questions:
On January 1, 20x1, OCCIDENTAL WESTERN Co. issued its 12%, 3-year, ₱4,000,000 convertible
bonds at 110. Each ₱4,000 bond is convertible into 8 shares with par value per share of ₱400.
Principal is due on December 31, 20x3 but interests are due annually at each year-end. When the
bonds were issued, they were selling at a yield to maturity market rate of 10% without the
conversion option.

On December 31, 20x2, half of the bonds were converted into equity. Conversion costs incurred
amounted to ₱80,000.

14. How much is the net increase in equity as a result of the conversion?
a. 1,687,375 b. 2,043,132 c. 1,956,364 d. 1,897,096

➢ Answer (c) is correct.

pg. 12
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

PV of 1 at 10% for 3 periods 0.7513148

PV of ordinary annuity of 1 at 10% for 3 periods 2.4868520
Issue price (4,000,000 × 110%) 4,400,000
less: FV of Debt Instruments
PV of Principal (4,000,000 × .7519148) 3,005,259
PV of Interest (480,000 × 2.486852) 1,193,689 (4,198,948)
Residual amount (Equity components) 201,052

Share Capital {[(4,000,000 ÷ 4,000) × 8] × 400} ÷ 50% 1,600,000

Share premium [(4,072,727 × 50%) - 1,600,000] - 80,000] 356,364
Net increase in equity 1,956,364

Interest payment Interest expense Premium Present

Date
(12%) (10%) Amortization value
Jan. 1, 20x1 4,198,948
Dec. 31, 20x1 480,000 419,895 (60,105) 4,138,843
Dec. 31, 20x2 480,000 413,884 (66,116) 4,072,727

15. How much is the net increase in “share premium” general account as a result of the
conversion?
a. 456,890 b. 391,660 c. 468,918 d. 473,413

➢ Answer (a) is correct.

Share premium [(4,072,727 × 50%) - 3,200,000] - 80,000] 356,364
add: 50% Residual amount (Equity components) 201,052 × 50% 100,526
Net increase in “share premium” general account 456,890

Conversion in between interest payment dates

Use the following information for the next two questions:
On January 1, 20x1, BLEARY DIMMED Co. issued its 12%, 3-year, ₱4,000,000 convertible bonds
at 110. The bonds are convertible into 8,000 shares with par value per share of ₱400. Principal is
due on December 31, 20x3 but interests are due annually at each year-end. At issuance date, the
bonds are selling at ₱4,198,948 without the conversion privilege. The effective interest rate is 10%.
On July 1, 20x2, all of the bonds were converted into equity. Conversion costs incurred amounted to
₱80,000. The accrued interest is settled separately in cash.

16. How much is the equity component of the compound instrument on January 1, 20x1?
a. 198,634 b. 201,052 c. 256,7324 d. 208,234

➢ Answer (b) is correct.

Issue price (4,000,000 × 110%) 4,400,000
less: FV of Debt Instruments (4,198,948)
Residual income (Equity component) 201,052

17. How much is the net credit to “share premium” account on July 1, 20x2?
a. 1,026,837 b. 1,012,334 c. 1,023,516 d. 1,234,012

➢ Answer (a) is correct.

PV of Bonds - Jun 30 4,105,785
Share equity (8,000 × 400) 3,200,000
Share premium 905,785
Share premium – conversion feature 201,052
Conversion costs (80,000)
Net credit to Share premium Account 1,026,837

pg. 13
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Interest payment Interest expense Present

Date (12%) (10%) Amortization value
Jan. 1, 20x1 4,198,948
Dec. 31, 20x1 480,000 419,895 (60,105) 4,138,843
July 1, 20x2 240,000 206,942 (33,058) 4,105,785

18. On January 1, 20x4, Aissa Company issued 10,000 of its 12%, P1,000 face value bonds at 95
plus accrued interest. The bonds are dated October 1, 20x3, and mature on October 1, 20x9.
Interest is payable semiannually on April 1 and October 1. Accrued interest from last interest
date, which amounted to P300,000 was also received. Aissa paid bond issue cost of
P250,000. On January 1, 20x4, what should Aissa report as bonds payable?
a. 9,250,000 b. 9,500,000 c. 9,600,000 d. 9,400,000

➢ Answer (b) is correct. 9,500,000 (10,000 × 1,000 × 95%)

19. On January 1, 2023, Jennifer Company issued 5,000 of its 12%, P1,000 face value bond at 95
plus accrued interest. The bonds are dated October 1, 2022 and mature on October 1, 2032.
Interest is payable semiannually on April 1 and October 1. Accrued interest for the period
October 1, 2022 to January 1, 2023 amounted to P150,000. Jennifer paid bond issue costs of
P200,000. On January 1, 2023, what amount should Jennifer report as bonds payable?
a. 4,750,000 b. 4,700,000 c. 5,000,000 d. 4,550,000

➢ Answer (a) is correct. 4,750,000 (5,000 × 1,000 × 95%)

20. On December 31, 2023, Celina Company issued 5,000 of its 8%, 10-year, P1,000 face value
bonds with detachable stock warrants at par. Each bond carried a detachable warrant for one
share of Celina’s common stock at a specified option price of P25 per share. Immediately after
issuance, the market value of the bonds without the warrants was P5,400,000 and the market
value of the warrants was P6,000,000. In its December 31, 2023 balance sheet, what amount
should Celina report as bonds payable?
a. 5,000,000 b. 4,875,000 c. 4,500,000 d. 4,400,000

➢ Answer (c) is correct. 4,500,000 (5,000,000 × 5,400/6,000)

21. On July 1, 2023, Vima Company issued P8,000,000 of 12% bonds payable, maturing in 10
years. The bonds pay interest semiannually. The bonds include detachable warrants giving
the bondholder the right to purchase for P30 one share of P1 par value common stock at
anytime during the next 3 years. The bonds and warrants were sold for P8,800,000. The value
of the warrants at the time of issuance was P1,000,000. No valuation of the bonds, separate
from the warrants, is available. On July 1, 2023 the bonds payable should be reported at
a. 8,000,000 b. 8,800,000 c. 7,800,000 d. 8,400,000

➢ Answer (c) is correct.

Issue price 8,800,000
less: Market value of warrants (1,000,000)
Issue price of bonds payable 7,800,000

22. On July 1, 2023, Yard Corporation issued its 12% P5,000,000, ten year bonds at a premium of
P880,000. Each P1,000 bond had 5 detachable stock warrants eligible for the purchase of one
share of Yard's P50 par value common stock for P75. Immediately after the bonds were
issued, Yard's 12% bonds excluding the warrants were setting at 110 while the warrants and
the common stock had quoted market value of P20 and P75 respectively. What amount of the
bond issue proceeds should Yard record as an increase in stockholders' equity?
a. 600,000 b. 105,000 c. 490,000 d. 0

➢ Answer (c) is correct.

pg. 14
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Market value Fraction Allocated issue price

Bonds payable (5,000,000 × 110%) 5,500,000 55/60 5,390,000
Warrants [(5,000,000 ÷ 1,000) × 5 × 20] 500,000 5/60 490,000
6,000,000 5,880,000

23. On July 1, 2023 Lino Company issued 12% bonds with maturity value of P10,000,000 together
with 100,000 shares of P50 par value common stock for a combined cash amount of
P20,000,000. The market value of Lino’s stock cannot be ascertained. If the bonds were
issued separately, they would have sold for P12,000,000 on an 8% yield to maturity basis.
What amount should Lino report for additional paid-in capital on the issuance of the common
stock?
a. 8,000,000 b. 3,000,000 c. 7,000,000 d. 5,000,000

➢ Answer (b) is correct.

Total issue price 20,000,000
less: MV of bonds payable (12,000,000)
Issue price of common 8,000,000
less: Par value of common (100,000 x P50) 5,000,000
Share premium 3,000,000

24. On January 1, 2023 May Ann Company issued at 120, 10,000 of its 9% P1,000 face value
bonds. Interest is payable semiannually on January 1 and July 1 and the bonds mature on
January 1, 2028. My Ann paid P500,000 bond issue cost which is appropriately recorded as a
deferred charge. May Ann use the straight-line method of amortization. On the December 31,
2023 balance sheet, what is the bond liability?
a. 10,000,000 b. 11,600,000 c. 11,200,000 d. 12,000,000

➢ Answer (b) is correct.

Bonds payable 10,000,000
Premium on bonds payable (2,000,000 × 4/5) 1,600,000
Bond liability 11,600,000

25. On January 1, 2024, Jackielee Company issued P8,000,000 of 12% bonds payable maturing
in 5 years. The bonds pay interest semiannually. The bonds include detachable stock warrants
giving the bondholder the right to purchase for P150 per share of Jackielee's P100 par value
common stock within the next three years. The bonds and warrants were issued at 110. The
value of the warrants at the time of issuance was P1,000,000. No valuation of the bonds
separate from the warrants is available. On December 31, 2024, the interest expense
recorded for the bonds payable is
a. 1,000,000 b. 960,000 c. 800,000 d. 920,000

➢ Answer (a) is correct.

Proceeds 8,000,000 × 1.10 8,800,000
less: MV of warrants (1,000,000)
Value assigned to Bonds payable 7,800,000
less: Bonds payable 8,000,000
Discount on bonds payable 200,000

Interest accrued on bonds (8,000,000 × 12%) 960,000

Discount amortization (200,000 ÷ 5) 40,000
Interest expense 1,000,000

26. Lara Company showed the following balances in connection with its noncurrent liabilities on
December 31, 2023.

Bonds payable -10%, maturing December 31, 2028 10,000,000

pg. 15
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

Bonds payable -12%, maturing December 31, 2033 8,000,000

Discount on bonds payable 800,000
Premium on bonds payable 500,000
Bond issue cost 200,000

The discount is related to the 10% bonds payable and the premium and bond issue costs are
applicable to the 12% bonds payable. No bonds were retired during 2023. How much interest
expense on the bonds payable should Lara report in its 2005 income statement?
a. 2,090,000 b. 2,070,000 c. 1,870,000 d. 1,890,000

➢ Answer (a) is correct.

Bonds payable - (10,000,000 × 10%) 1,000,000
Bonds payable - (8,000,000 × 12%) 960,000
Discount amortization (800,000 × 1/5) 160,000
Premium amortization (500,000 × 1/10) (50,000)
Bond issue cost amortization (200,000 × 1/10) 20,000
Total interest 2,090,000

27. On November 1, 2023, Emmanuela Company issued P20,000,000 of its 10-year, 8% term
bonds dated October 1, 2003. The bonds were sold to yield 10%, with total proceeds of
P18,000,000 plus accrued interest. Interest is paid every April 1 and October 1. What amount
should Emmanuela report for interest payable in its December 31, 2023 balance sheet?
a. 500,000 b. 400,000 c. 450,000 d. 360,000

➢ Answer (b) is correct. Accrued interest from Oct 1 to Dec 31, 2023 = 400,000 (20,000,000 ×
8% × 3/12)

28. Portia Corporation had two issues of securities outstanding - common stock and a 5%
convertible bond issue in the face amount of P10,000,000. Interest payment dates of the bond
are June 30 and December 31. The conversion clauses in the bond indenture entitles the
bondholder to receive 40 shares of P20 par value common stock in exchange for each P1,000
bond. On June 30, 2023, the holders of P5,000,000 face value bonds exercised the
conversion privilege. The market price of the common stock was P35. The total unamortized
bond discount at the date of conversion was P500,000. What amount was credited to
"additional paid in capital" as a result of the conversion?
a. 1,000,000 b. 1,250,000 c. 750,000 d. 0

➢ Answer (c) is correct.

CV of bonds converted (5,000,000 - 250,000) 4,750,000
less: Par value of CS issued (5,000 × 40 × 20) (4,000,000)
APIC from conversion 750,000

Theory:
29. The result on the year-end balance sheet of an issue of a 10-year term bond sold at face
amount four years ago with interest payable June 1 and December 1 each year, is a(an)
a. liability for accrued interest c. increase in deferred charges
b. addition to bonds payable d. contingent liability

30. Unamortized bond discount should be reported on the financial statements of the issuer as a
a. Direct deduction from the face amount of the bond
b. Direct deduction from the present value of the bond
c. Deferred charge
d. Part of the issue costs

31. Straight-line amortization of bond premium or discount:

a. can be used as an optional method of amortization in all situations.

pg. 16
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

b. provides the same total amount of interest expense and interest revenue as the effective
interest method over the life of the bonds.
c. provides the same amounts of interest expense and interest revenue each interest period
as the effective interest method.
d. is appropriate when the bond term is especially long.
e. is appropriate for deep discount bonds.

32. For a bond issue which sells for less than its face amount, the market rate of interest is
a. Dependent on the rate stated on the bond.
b. Equal to rate stated on the bond.
c. Less than rate stated on the bond.
d. Higher than rate stated on the bond.

33. The market price of a bond issued at a discount is the present value of its principal amount at
the market (effective) rate of interest
a. Less the present value of all future interest payments at the market (effective) rate of
interest.
b. Less the present value of all future interest payments at the rate of interest stated on the
bond.
c. Plus the present value of all future interest payments at the market (effective) rate of
interest.
d. Plus the present value of all future interest payments at the rate of interest stated on the
bond.

34. The issue price of a bond is equal to the present value of the future cash flows for interest and
principal when the bond is issued (Item #1) At par; (Item #2) At a discount; (Item #3) At a
premium
a. Yes, No, Yes b. Yes, No, No c. No, Yes, Yes d. Yes, Yes, Yes

35. Costs incurred in connection with the issuance of ten-year bonds which sold at a slight
premium should be
a. Charged to retained earnings when the bonds are issued
b. Expensed in the year in which incurred
c. Capitalized as organization cost
d. Reported on the balance sheet as a deduction from bonds payable and amortized over the
ten-year bond term

36. When the interest payment dates of a bond are May 31 and November 30, and a bond issue is
sold on July 1, the price of the bond will be:
a. decreased by accrued interest from July 1 to November 30.
b. decreased by accrued interest from May 31 to July 1.
c. increased by accrued interest from May 31 to July 1.
d. increased by accrued interest from July 1 to November 30.
e. unaffected by accrued interest.

37. A company issued ten-year term bonds at a discount in the current year. Bond issue costs
were incurred at that time. The company uses the effective interest method to amortize bond
issue costs. Reporting the bond issue costs as a deferred charge would result in
a. More of a reduction in current year’s net income than reporting the bond issue costs as a
reduction of the related liability
b. The same reduction in current year’s net income as reporting the bond issue costs as a
reduction of the related debt liability
c. Less of a reduction in current year’s net income than reporting the bond issue costs as a
reduction of the related debt liability
d. No reduction in current year’s net income

pg. 17
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

38. In theory the proceeds from the sale of a bond will be equal to
a. The face amount of the bond
b. The present value of the principal amount due at the end of the life of the bond plus the
present value of the interest payments made during the life of the bond
c. The face amount of the bond plus the present value of the interest payments made during
the life of the bond
d. The sum of the face amounts of the bond and the periodic interest payments.

39. In current accounting practice, the valuation method used for bonds payable is
a. Historical
b. Discounted cash-flow valuation at current yield rates
c. Maturity amount
d. Discounted cash-flow valuation at yield rates at issuance

40. QUIRK ACCIDENT Company issued bonds with detachable share warrants. Both the warrants
and the bonds have separate identifiable fair values. The sum of the fair value of the warrants
and face amount of the bonds exceeds the cash proceeds but the proceeds assigned to the
bonds are less than the face amount of the bonds. The excess of the face amount over the
assigned proceeds to the bonds is reported as
a. Discount on bonds payable c. Share premium in excess of par
b. Premium on bonds payable d. None of these

41. On January 1 of the current year, NOMENCLATURE NAME Company issued bonds at a
discount. NOMENCLATURE incorrectly used the straight line method instead of the effective
interest method to amortize the discount. How were the following amounts, as of December 31
of the current year, affected by the errors?

(Item #1) Bond carrying amounts; (Item #2) Retained earnings

a. Overstated, Overstated c. Overstated, Understated
b. Understated, Understated d. Understated, Overstated

42. What is the preferred method of handling unamortized discount, issue cost, and redemption
premium on bonds refunded?
a. Expense them in the period the bonds are refunded
b. Amortize them over the life of the new issue
c. Amortize them over the remaining life of the issue retired
d. Charge them to retained earnings

43. When a ₱1,000,000 face amount bonds is issued at 102, there is

a. 2,000 bond discount c. 20,000 bond premium
b. 2,000 bond premium d. 20,000 bond discount

44. When an entity retires bonds with an unamortized discount at a premium, there is
a. gain on extinguishment c. either gain or loss
b. loss on extinguishment d. cannot be determined
45. Use of the effective-interest method in amortizing bond premiums and discounts results in
a. a greater amount of interest expense over the life of the bond issue than would result from
the use of the straight-line method
b. a varying amount being recorded as interest expense from period to period
c. a variable effective rate on the bond issue from period to period over life of the bonds
d. a smaller amount of interest expense over the life of the bond issue than would result from
use of the straight-line method

46. When an entity retires bonds with an unamortized discount at a premium,

a. the unamortized discount decreases loss on extinguishment
b. the unamortized discount increases loss on extinguishment
pg. 18
 Compound Financial Instruments
Felix L. Domingo, CPA, CMA

c. the unamortized discount increases gain on extinguishment

d. the unamortized discount decreases gain on extinguishment

47. An entity uses the effective interest method in amortizing bond discount. Which of the
following is incorrect regarding the bond discount amortization?
a. Periodic interest expense increases over the life of the bonds.
b. Periodic interest expense is greater than periodic interest payments.
c. The carrying amount of the bonds increases over the life of the bonds.
d. Amortization decreases over the life of the bonds.

48. An entity uses the effective interest method in amortizing bond premium. Which of the
following is incorrect regarding the bond premium amortization?
a. Periodic interest expense decreases over the life of the bonds.
b. Periodic interest expense is greater than periodic interest payments.
c. The carrying amount of the bonds decreases over the life of the bonds.
d. Amortization increases over the life of the bonds.

49. The market price of a bond issued at a premium is equal to the present value of its principal
amount:
a. Only, at the stated interest rate.
b. And the present value of all future interest payments, at the stated interest rate.
c. Only, at the market (effective) interest rate.
d. And the present value of all future interest payments, at the market (effective) interest rate.

50. On March 1, 20x1, LIAISON INTERCOMMUNICATION Co. issued 20-year bonds at a

discount. By September 1, 20x6, the bonds were quoted at 106 when LIAISON exercised its
right to retire the bonds at 105. The amount is material and considered to be unusual in nature
and infrequently occurring with respect to LIAISON Co. How should LIAISON report the bond
retirement on its 20x6 income statement?
a. A gain in continuing operations. c. An extraordinary gain.
b. A loss in continuing operations. d. An extraordinary loss.

51. Which of the following is true for a bond maturing on a single date when the effective interest
method of amortizing bond discount is used?
a. interest expense as a percentage of the bond’s carrying amount varies from period to
period
b. interest expense increases each six-month period
c. interest expense remains constant each six-month period
d. nominal interest rate exceeds effective interest rate

52. If term bonds are sold at a discount and the effective interest method of amortization is used,
interest expense will:
a. Increase from one period to another.
b. Remain constant from one period to another.
c. Equal the cash interest payment each period.
d. Be less than the cash interest payment each period.

53. Which of the following is/are true with respect to bonds

a. They can be issued for cash
b. They can be issued for consideration other than cash
c. They can be issued with collateral security
d. They cannot be retired prior to maturity
e. (a), (b) and (c) of the above.

pg. 19