On January 1, Year 1, O'Keefe Co. issued bonds with a face value of $400,000 and a stated interest rate of 10%. The bonds have a life of ten years and were sold at 108. O'Keefe uses the straight-line method to amortize bond discounts and premiums. On December 31, Year 4, O'Keefe called the bonds at 106. Indicate whether each of the following statements is true or false.________ a) The interest expense for Year 1 was $40,000.________ b) The balance in the bonds payable account was $400,000 on December 31, Year 1.________ c) The carrying value of bonds payable was $419,200 on December 31, Year 4.________ d) When O'Keefe repurchased the bonds, total assets decreased by $419,200.________ e) When O'Keefe repurchased the bonds, it had to recognize a loss in the amount of $4,800.
What will be an ideal response?
a) F b) T c) T d) F e) T
a) This is false. Interest payment = $400,000 × $10% = $40,000; Premium = Face value of $400,000 × 8% = $32,000; Amortization of premium = Premium of $32,000 ÷ 10 years = $3,200 per year; Year 1 Interest expense = Cash payment of $40,000 ? Premium amortization of $3,200 = $36,800
b) This is true. The balance in the bonds payable account is $400,000, the face value of the bonds, the entire time that the bonds are outstanding. Only the premium on bonds payable account changes.
c) This is true. Issue price = Face value of $400,000 × 108% = $432,000; Carrying value at December 31, Year 4 = $432,000 ? [Amortization of $3,200 per year (computed in part a × 4 years)] = $419,200
d) This is false. Total assets decreased by the call price of $424,000 (or Face value of $400,000 × Call price of 106%).
e) This is true. Loss on bond redemption = Call price of $424,000 (computed in part d) ? Carrying value of $419,200 at December 31, Year 4 (computed in part c) = $4,800
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