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Unformatted text preview: 1 Questions Chapter 14 3. (a) Yield ratethe rate of interest actually earned by the bondholders; it is synonymous with the effective and market rates. (b) Nominal ratethe rate set by the party issuing the bonds and expressed as a percentage of the par value; it is synonymous with the stated rate. (c) Stated ratesynonymous with nominal rate. (d) Market ratesynonymous with yield rate and effective rate. (e) Effective ratesynonymous with market rate and yield rate. 4. (a) Maturity valuethe face value of the bonds; the amount which is payable upon maturity. (b) Face valuesynonymous with par value and maturity value. (c) Market valuethe amount realizable upon sale. (d) Par valuesynonymous with maturity and face value. 5. A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk. They refuse to pay par for the bonds and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest. A premium on bonds payable results from the opposite conditions. That is, when investors are satisfied with a rate of interest lower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order to acquire them, thus reducing their effective rate of interest below the stated rate. 6. Discount (premium) on bonds payable should be reported in the balance sheet as a direct deduction from (addition to) the face amount of the bond. Both are liability valuation accounts. 7. Bond discount and bond premium may be amortized on a straightline basis or on an effectiveinterest basis. The profession recommends the effectiveinterest method but permits the straightline method when the results obtained are not materially different from the effectiveinterest method. The straightline method results in an even or average allocation of the total interest over the life of the notes or bonds. The effectiveinterest method results in an increasing or decreasing amount of interest each period. This is because interest is based on the carrying amount of the bond issuance at the beginning of each period. The straightline method results in a constant dollar amount of interest and an increasing or decreasing rate of interest over the life of the bonds. The effectiveinterest method results in an increasing or decreasing dollar amount of interest and a constant rate of interest over the life of the bonds. 2 EXERCISE 143 (1520 minutes) 1. Divac Company: (a) 1/1/10 Cash..................................................... 300,000 Bonds Payable ........................... 300,000 (b) 7/1/10 Interest Expense ($300,000 X 9% X 3/12) .................... 6,750 Cash ........................................... 6,750 (c) 12/31/10 Interest Expense .................................(c) 12/31/10 Interest Expense ....
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 Spring '11
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 Financial Accounting

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