Page 621 - Accounting Principles (A Business Perspective)

15. Long-term financing: Bonds

d. USD 19,585.
Assume a company has net income of USD 100,000, income tax expense of USD 40,000, and interest expense of
USD 20,000. The times interest earned ratio is:

a. 5 times.
b. 7 times.
c. 8 times.
d. 9 times.
Now turn to “Answers to self-test”at the end of the chapter to check your answers.

Questions
➢ What are the advantages of obtaining long-term funds by the issuance of bonds rather than
additional shares of capital stock? What are the disadvantages?

➢ What is a bond indenture? What parties are usually associated with it? Explain why.
➢ Explain what is meant by the terms coupon, callable, convertible, and debenture.
➢ What is meant by the term trading on the equity?
➢ When bonds are issued between interest dates, why should the issuing corporation receive cash equal
to the amount of accrued interest (accrued since the preceding interest date) in addition to the issue
price of the bonds?
➢ Why might it be more accurate to describe a sinking fund as a bond redemption fund?

➢ Indicate how each of the following items should be classified in a balance sheet on 2009 December
31.

➢ Cash balance in a sinking fund.
➢ Accrued interest on bonds payable.
➢ Debenture bonds payable due in 2019.
➢ Premium on bonds payable.
➢ First-mortgage bonds payable, due 2010 July 1.
➢ Discount on bonds payable.

➢ First National Bank—Interest account.
➢ Convertible bonds payable due in 2012.
➢ Why is the effective interest rate method of computing periodic interest expense considered
theoretically preferable to the straight-line method?
➢ Why would an investor whose intent is to hold bonds to maturity pay more for the bonds than their
face value?
➢ Of what use is the times interest earned ratio?

Exercises
Exercise A On 2010 September 30, Domingo's Construction Company issued USD 120,000 face value of 12 per
cent, 10-year bonds dated 2010 August 31, at 100, plus accrued interest. Interest is paid semiannually on February
28 and August 31. Domingo's accounting year ends on December 31. Prepare journal entries to record the issuance
of these bonds, the accrual of interest at year-end, and the payment of the first interest coupon.

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