1 Questions Chapter 14 3.(a) Yield rate—the rate of interest actually earned by the bondholders; it is synonymous with the effective and market rates. (b) Nominal rate—the 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 rate—synonymous with nominal rate. (d) Market rate—synonymous with yield rate and effective rate. (e) Effective rate—synonymous with market rate and yield rate. 4. (a) Maturity value—the face value of the bonds; the amount which is payable upon maturity. (b) Face value—synonymous with par value and maturity value. (c) Market value—the amount realizable upon sale. (d) Par value—synonymous 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 straight-line basis or on an effective-interest basis. The profession recommends the effective-interest method but permits the straight-line method when the results obtained are not materially different from the effective-interest method. The straight-line method results in an even or average allocation of the total interest over the life of the notes or bonds. The effective-interest 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 straight-line method results in a constant dollar amount of interest and an increasing or decreasing rate of interest over the life of the bonds. The effective-interest method results in an increasing or decreasing dollar amount of interest and a constant rate of interest over the life of the bonds.
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