Solutions to Exercises and Problems Chapter 10(Revised)

Solutions to Exercises and Problems Chapter 10(Revised) -...

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Chapter 10 Reporting and Analyzing Long-Term Liabilities QUESTIONS 1. A bond is a liability of the issuing company. A share of stock represents an ownership interest in the company. 2. Notes payable generally involve borrowing from a single creditor, whereas bonds payable are usually sold to many different lenders (bondholders). 3. Bonds can allow a company’s owners to increase their return on equity without investing additional amounts. This result occurs as long as the rate of return on the assets acquired from the borrowed cash is greater than the interest rate paid on the bonds. Bonds also help the current owners remain in control of the company. There is also a tax advantage with bonds when issued by corporations. 4. A trustee for bondholders has the responsibility of monitoring the issuer’s actions, financial performance, and financial condition to ensure that the obligations in the bond indenture are met. 5. A bond indenture is a legal contract between the issuing company and the bondholders that identifies the obligations and rights of both parties. It specifies such items as the par value of the bonds, the contract interest rate, the due dates for interest payments, and the maturity date(s) of the bonds. It also may name a trustee, describe the bond issue in detail, and provide for a sinking fund. 6. The contract rate (also known as the coupon rate, stated rate, or nominal rate) is the rate that is identified in the bond indenture. It is applied to the par value to determine the size of the cash interest payments. The market rate is the consensus rate that a company is willing to pay and that investors are willing to accept for a specific bond. 7. In general, the supply of and demand for bonds affect market rates. The market rate for a particular bond issue is also affected by risks unique to the issuer (e.g., financial performance and condition) and the length of time until the bonds mature. 8. B The effective interest method creates a constant rate of interest over a bond’s life because the market rate at the time of issuance is multiplied by the beginning balance for each period. The straight-line method produces either an increasing or decreasing rate because it allocates the same amount of expense to each period, even if the liability balance is growing (a discount) or decreasing (a premium).
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9. C When issuing bonds between interest dates, a company collects accrued interest from the purchasers to avoid keeping detailed records of bond purchasers and the dates when bonds are purchased. If the company did not collect accrued interest, individual checks would be needed to pay the correct amount of interest to each purchaser. By collecting in advance, the issuer merely distributes the same amount per check to all bondholders, regardless of when they purchased the bonds.
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